The importance of supply chains
Financial Reporting Brief: August 2022
Supply chains had seldom featured in companies’ earnings reports in the first three decades since globalisation took off in earnest, save for the occasional mention of the benefits of low costs and lean inventories.
This has changed very significantly in the past couple of years. The global outbreak of the COVID-19 pandemic caused widespread upheaval from 2020 onwards, and enormous further strain has been brought about in 2022 by the Russia-Ukraine war. Brexit has also given rise to additional severe difficulties for those engaged in overseas trading. The reality is that very few escape as, either in business or as consumers, we all depend on the reliability of supply chains. All three factors referred to here continue to be predominant. Even if we may be emerging from the worst impact of COVID-19 it continues to be a major social and economic challenge in many parts of the world.
Oil, gas, wheat/corn – Russia and the Ukraine are major providers to the world’s markets, which is in plain view for all to see. A little less apparent may be that both countries are key providers of many natural resources and minerals key to production and related activities – for example, palladium (70%) and neon (40%) – without which the production of cars, computer chips and semi-conductors could not be carried out. While this has a direct impact on primarily auto-makers, electronics companies and phone-makers, it is abundantly clear that disruption to production of those has a hugely pervasive negative impact on the whole economy and consumers suffer the consequences.
It is of extreme concern that there is no end in sight to the Russia-Ukraine war. The invasion will bring longer-lasting supply chain disruption and the trade outlook will also have to contend with the consequences of sanctions.
Companies are operating in an environment where the importance of sustainability and the demand for ‘green’ products is growing inexorably. A company’s entire supply chain can make a significant impact in promoting human rights, fair labour practices, environmental progress and anti-corruption policies. UN Global Compact participants rank supply chain practices as the biggest challenge to improving their sustainability performance.
Extending the UN Global Compact’s Ten Principles into the supply chain can be difficult because of the scale and complexity of many supply chains. The UN Global Compact encourages companies to make sustainability a priority from the top of the organization. If the supply chain is seen as an extension of the workforce and community, a company can set expectations for best practices across its supply chain. Supply chain sustainability must extend beyond the resourcing of materials through to end-stage with strategies needed for re-use, recycle and retirement of products. Key stakeholders increasingly expect the brands they buy and support to address sustainability issues.
The extreme challenges being faced and the major uncertainties brought about by the Russia-Ukraine war, and the continuation of other challenges, must be fully considered by those engaged in corporate reporting. Investors and other stakeholders should at all times be informed by reliable, transparent reporting.
The Reporting Challenge
There has been much advice and guidance on how to deal with the implications of the Russia-Ukraine war for financial reporting. This includes the Public Statement by the European Securities and Markets Authority (ESMA), which highlights the following considerations:
- A reminder of the main areas of accounting where IFRS requirements may have significant impact on reported financial information e.g. loss of control, impairment, ability to forecast cash flows;
- Importance of adequate disclosure in financial statements in relation to judgements made, significant uncertainties and going concern risks;
- Management report comment to include direct and indirect impact of the war and the sanctions imposed, and measures taken to mitigate the impacts; and
- A reminder of issuers’ obligations vis-à-vis the Market Abuse Regulations.
Our publication Financial Reporting Considerations related to the Russia-Ukraine War outlines valuable insights and commentary.
Our Financial Reporting Brief article in April 2020 ‘COVID-19 : The New Normal’ commented on the wide range of corporate reporting considerations emanating from the outbreak of the pandemic and the consequent lockdown. The considerations are very similar with the war in Ukraine, except that the world was largely in unison in 2020 and now the war has led to major global upheaval which has sharpened the focus on many considerations and created even more difficulty in key areas such as performance/cash flow forecasting and asset impairment reviews.
The impact of the war may differ widely depending on the nature and circumstances of your company. Even entities that do not have direct exposure to Ukraine or Russia are likely to be affected by the overall economic uncertainty and negative impacts on the global economy and major financial markets arising from the war.
Importance of Disclosure
The UK Financial Reporting Council (FRC) Lab has published an Insight
on supply chain disclosure.
It emphasises that supply chains are critical to creating long-term value for businesses, and clear and concise disclosures on supply chains are key to investor understanding and confidence.
Investors are likely to look for information that helps them understand:
- The context of the supply chain. This means the size and scope of the businesses supply chain, its nature and resilience to change and turbulence, the extent to which sustainable procurement practices are embedded and the impact on current and future operations, reputation and brand; and
- The impact of supply chain uncertainties, risks and opportunities on long-term value creation and the actions management are taking to address these.
Investors want to understand what the major impacts on the effective implementation of a company’s business model are. All companies have a supply chain, be it short or long, complex and multi-faceted or otherwise.
Information in relation to a company’s supply chain that would be valuable to investors and other stakeholders includes the following:
- What raw materials and goods are critical to the business model in the short and medium term? How has the supply chain for these elements been impacted by global disruptions?
- What, if any, international or local restrictions exist that might impact a supplier's ability to deliver? For example, are suppliers based in areas impacted by active war, sanctions, or COVID-related restrictions? How concentrated is this risk?
- To what extent is the supply chain reliant on critical components? What risks do they pose and what mitigating actions are in place?
- What is the impact of inflationary pressures on the supply chain?
- What actions are management taking to actively monitor and manage these risks? How are longer-term impacts being considered and planned for?
Many consumers and businesses now operate predominantly online, making secure data transmission critical. Cyber-attacks are an escalating concern. Investors are keen to understand a company’s digital infrastructure, including supply chain components that are critical to its business model, and the control environment within which it operates.
There are legal, ethical and reputational considerations to different degrees in supply chains with the more multi-faceted models being exposed to multi-jurisdictional concerns. Investors are keen to understand matters which include:
- How does a company assess its suppliers and their owners?
- How do they take into account potential legal and reputational risks and what mitigations are in place?
- How do they monitor ongoing relationships with suppliers, including the possibility of relying on external parties for verification?
- When changing suppliers, is the change consistent with wider business cultural values, for example, ESG commitments?
Providing a connected and clear story, which provides information on governance and processes integral to the supply chain, the nature and approach, as well as any relevant scenarios planning information will help investors in their understanding of the nature and resilience of the supply chain.
Management of Supply Chain
It is vital that a company has a clear strategy with regard to its supply chain, including its sustainability, observance of ethical principles, its resilience to disruption and adaptability to change. Transactional efficiency should be considered in the context of the overall strategy which should have long-term values firmly in focus.
The overall direction and management of a company is normally overseen by strong corporate governance principles, which primarily focus on what happens inside the organisation and goes outside only sparingly. The supply chain should have its own governance principles focused on what happens along the supply chain as it relates to what happens inside the organisation and adherence to a company’s strategic principles, including those related to long-term sustainability.
Supply chain governance needs a different set of skills, which go beyond the form of the agreements into the substance of the deals. Significant supply chain experience may be required for this purpose and it is important that companies have the requisite capabilities. The currently disrupted and stressed global trading and supply operations demand that companies, particularly those with complex supply chains, have those capabilities which may be vital to continuing operational capability.
Conclusion
Investors and other stakeholders have a valid expectation that a company will provide in its corporate reporting information on how its supply chain is being managed as a key component of its business model and overall strategy, with a clear description of risks and mitigating measures.
Those that provide reliable, transparent disclosure will give investors and other stakeholders a better foundation for making capital allocation and other economic decisions.
Management Reporting Brief – July 2022
Irish/ UK GAAP & Related Developments
FRC publishes thematic review of judgements and estimates
FRC publishes guidance on running effective AGMs
FRC publishes research into stewardship practices of assets managers and asset owners
IFRS & Related Developments
ESMA expresses strong support for the ISSB's work on draft standards
FSB progress report on addressing climate-related financial risk
Second IVSC perspectives paper on social value
Legal & Regulatory Developments
New Corporate Enforcement Authority established
Publications
Resources and Publications
Welcome to our one-stop guide covering the issues relevant to the preparation of December 2021 annual reports.
Governance in focus — On the board agenda 2022
Our annual review of board topics will stimulate your thinking and help prepare you for the year ahead. Across the board, expectations of business are rising and it is this demanding environment which shapes the articles in this year’s publication.
Annual Report Insights 2021 - Surveying FTSE Reporting
Surveying FTSE reporting. Our yearly survey scours the annual reports of 100 listed UK companies and provides insight and inspiration ahead of the next reporting season.
IFRS Model Financial Statements 2021
The Model for 2021 illustrates the presentation and disclosure requirements of IFRS Standards and also contains ‘best practice’ examples.
IFRS in your pocket is a comprehensive summary of the current IFRS Standards and Interpretations along with details of the projects on the standard-setting agenda of the International Accounting Standards Board.
Understanding the differences between U.S. GAAP and IFRS Standards
A comprehensive 380-page publication focusing on some of the most common and significant differences that may affect financial statements when converting from U.S. GAAP to IFRS Standards and vice versa. Updated to 2022.
IFRS Foundation Trustees' sustainability reporting initiative
Summary of continuing developments.
Today’s climate crisis urges us to reinvent our economy. Business needs to change to meet higher expectations of sustainability and Deloitte is well-equipped to guide organisations through this change. Together we can rewrite the playbook on authentic business responsibility.
Operations reimagined and reconfigured - how do we embrace a future of change without losing focus on our purpose? We help you think holistically about the transformation process, so you're reskilling your people, redeploying your assets, and refreshing your technology stack.
Deloitte resources on financial reporting implications of Brexit, including links to news and publications.
Highlights some of the key accounting and disclosure issues to be considered by entities that may arise as a result of COVID-19 in preparing financial statements.
Enhanced IFRS e-learning website
Our IFRS e-learning platform allows external users to complete over 40 of Deloitte’s IFRS e-learnings free of charge with 6 million+ uses in recent years.
