Risks, Uncertainties and Concentrations

During our year-end work, we inquire about major customers and major vendors, and information regarding other concentrations in your business operations.

We ask for this information because we are required under Statement of Position (SOP) 94-6 Disclosure of Certain Significant Risks and Uncertainties issued by the AICPA (American Institute of Certified Public Accountants) to disclose information about risks and uncertainties existing as of the date of financial statements which are prepared in conformity with generally accepted accounting principles (GAAP). This accounting standard evolved from an AICPA report which reviewed the need for improved disclosure in our business and economic environment.

Under the SOP, businesses will disclose in their financial statements at a minimum the following –

a. A description of major products or services, including principal markets and the location of those markets.
b. If the company operates in more than one business, the relative importance of each business and the basis for determining relative importance.
c. An explanation that preparing the financial statements in conformity with GAAP involves the use of management’s estimates.
d. The nature of estimates used in the financial statements and an indication that it is reasonably possible that a change may occur in the near term (a period not to exceed one year from the financial statement date).

Additionally, the financial statements may be required to disclose concentrations such as the following -

a. Concentrations in the volume of business transacted with a particular customer, supplier, lender, grantor, or contributor.
b. Concentrations in revenue from particular products, services, or fund-raising events.
c. Concentrations in the available sources of supply of materials, labor, or services, or of licenses or other rights used in the entity’s operations.
d. Concentrations in the market or geographic area in which an entity conducts its operations.

The disclosure should include information that is adequate to inform users of the general nature of the risk associated with the concentration.

So what does this mean? Does every concentration need to be disclosed? No—only those that could have a near-term severe impact to your business. Following are some examples of the types of concentrations that would require disclosure.

a. Suppliers: If a majority of a product or component is obtained from one supplier and there are limited or no alternative suppliers for that product or component, a change in supplier could significantly disrupt the business due to the time it would take to locate and qualify a new vendor. In this case, disclosure would be required. If numerous alternate sources of supply are available on comparable terms, no disclosure would be necessary.
b. Customers: If a significant portion of revenue is derived from sales to one customer and the reduction of sales to or loss of that customer could significantly disrupt business, disclosure would be required. If all customers are relatively small purchasers, no disclosure would be necessary.

Please feel free to call me for assistance at (425) 454-7990 or email jbriggs@bpcpa.com if you have any questions regarding this important financial statement disclosure. In this current economic environment, this issue is very important to banks, sureties and other third party readers of financial statements.

Judy Briggs, CPA
Assurance Services Dept.