A company purchases substantially all of its raw materials from a single overseas supplier and discloses in its notes that a sudden loss of that supplier could severely disrupt production within the next year. Under ASC 275 (Risks and Uncertainties), which required disclosure category does this describe?
- The nature of operations disclosure, describing the entity's primary business activities
- Vulnerability due to certain concentrations, since the entity is exposed to a risk of loss it has not mitigated through diversification
- Use of estimates in the preparation of financial statements
- Certain significant estimates, limited to estimates that are already reflected in recognized amounts
Why B? And why not the others?
Correct answer: B. Vulnerability due to certain concentrations, since the entity is exposed to a risk of loss it has not mitigated through diversification
ASC 275-10-50 requires disclosure of vulnerability from certain concentrations — such as a concentration in a single supplier, customer, product, or geographic area — when it is at least reasonably possible that the concentration could cause a severe near-term impact, precisely because relying on one overseas supplier for substantially all raw materials leaves the entity exposed to a risk of loss it has not spread across multiple sources. The option describing the nature-of-operations disclosure is wrong because that category simply describes what the entity does, such as its principal products or services, rather than a specific vulnerability arising from a lack of diversification. The option describing the use-of-estimates disclosure is wrong because that category is a general statement that GAAP financial statements necessarily involve management estimates, unrelated to supplier concentration risk. The option describing certain significant estimates is wrong because that category addresses estimates that could reasonably change in the near term and have a material effect on amounts already recognized in the financial statements, whereas a supply-disruption risk is a concentration vulnerability rather than an estimate embedded in a recognized balance.
Source: FASB Accounting Standards Codification: ASC 275-10, Risks and Uncertainties