Accounting for Supply Risk Programs

Dec. 3, 2009
The strategic question companies need to concern themselves with is how to budget and fund supply risk programs.

While there is a broad continuum of modalities for budgeting and funding supply risk programs inside companies, organizations have fewer accounting methods at their disposal when it comes to such initiatives. These options further compress based on the specific types of purchases an organization is making (e.g., direct materials, indirect, capital, services) as well as the overall supply risk program design (e.g., one time, periodic or continuous). Still, even though the options available are limited -- not to mention making for dry subject matter -- all supply risk program owners should familiarize themselves with the accounting methods on hand. This short article provides a brief overview of some of the methods we have observed companies to use on a regular basis.

The first method we have observed companies use for direct materials and manufacturing related outsourcing -- not to mention overall supplier management and supply performance management programs -- accounts for initiatives under costs of goods sold or COGs. Under this model, companies attach all fees to a project as inventory. In using this method, an organization would assign direct supply risk expenses (including content, technology, employees, consultants, etc.) to the cost of the products purchased.

Using a COGs approach, a company incurs costs over the life of the purchase agreement between the customer and the supplier. To deploy a COGs treatment requires amortizing the costs of each individual supplier in a risk management system/process over all of the goods delivered in a finite period (e.g., quarterly, yearly, etc.) This approach, clearly, is limited only to manufacturers -- in the vast majority of cases -- or services providers where a particular expense is a direct component of COGs.

The second accounting method for supply risk is OPEX, or accounting for an expense as an operating expenditure tied to an ongoing product, business or system. Here, there are two common methods -- expense as incurred periodically or expense as incurred by project. Under the former approach, companies book expenses on a periodic (e.g., monthly, quarterly, etc.) basis as fees are billed to the project owner (e.g., procurement, finance, business unit, etc.) Under the latter OPEX accounting method, a company would expense fees as part of a discrete or broader set of initiatives (i.e., the project). In this approach, companies have to define projects based on specific contract terms and costs impact actual budget lines when projects are complete, or based on other contractual triggers.

Companies can also use a capital expenditure or CAPEX accounting approach for supply risk programs that they can attach to specific capital projects. Capital projects may be large (e.g., factories, buildings) or small, but must always be tied to future returns (vs. immediate benefit). Under this method, companies account for the expense as a component of the asset and must depreciate it over its useful life, as defined by specific accounting parameters.

The way a company opts to account for supply risk initiatives may differ based on each set of operating circumstances (and may include various methods based on spend type, projects, extraneous circumstances, etc.). But it is essential to remember that each organization has various options at its disposal. In many cases, the more important and strategic question companies need to concern themselves with is how to budget and fund supply risk programs (e.g. buyer-paid vs. supplier-paid models). However, understanding the specific accounting treatments will help procurement and supply chain organizations sell the broader concept of supply risk investment to finance and other business and budget stakeholders.

Jim Lawton is senior vice president and general manager of D&B Supply Management Solutions which combines global business insight and technology to help reduce supply risk.

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