Potential Transfer of Raw Material Supplies to an Overseas Supplier in a Politically Unstable Environment
Intended audience: Professional Accountants in Business
You are the Chairman of ABC Ltd, a long established specialist paper-making company. The company’s next board meeting is due to be held next month. Top of the agenda for the meeting is the possibility of changing the company’s source of raw materials.
This has come about because for some time now, the company has experienced falling profit margins. All of the directors had been tasked with identifying ways of reducing the cost base. One obvious target would be to reduce the level of the workforce but you only want to revert to this option as a last resort – the work force has been loyal and hard working.
Mr Y, the production director responsible for buying wood pulp, the primary raw material used in the production of paper, has recommended that the board considers shifting contracts away from existing Singaporean suppliers in favour of lower cost overseas suppliers. Supporting this view, the Chief Executive, Mr X, has specifically identified Company XYZ, a company based in a developing country. It is known that his family have an involvement in this company and that Mr X personally has a 10% equity stake. Despite the obvious conflict of interest, there is no doubt that this direct link to the supplier would be of benefit to ABC Ltd if it decided to take up this option. It would reduce the risks of dealing with a new supplier, particularly one which is based overseas.
In conversations you have had with some of the other directors, they have expressed concern that the image of ABC Ltd in the Singapore market will be damaged by withdrawing business from the domestic suppliers. At present, most of the pulp is purchased from one particular Singaporean supplier, SG Ltd, with the contract making up over 70% of that supplier’s business. The expected cost reductions for ABC Ltd are undeniable, but there is a fear that moving the contract will put the existing supplier out of business, and there would be the associated knock on effects in the local community.
It is also well known that the country from which it is proposed that the pulp be sourced in future, adopts indiscriminate policies towards deforestation (clearing forest areas), causing irreparable damage to the eco-system. Its government has consistently argued that the improvement in the quality of life of its people in rural areas must take priority over natural resources. Additionally, the political environment is fragile and the possibility of a coup is ever present.
Another factor is that only just under three years ago ABC Ltd received a regional development grant for $3,500,000 which was used towards the cost of renewing some of the company’s outdated equipment. This grant was partly awarded on the basis of retaining jobs in the local area. The qualifying period will expire in three months time and the local enterprise agency will not then be able to claw back any of the money – however, you are trying to square the logic of this with the undoubted damage it would do if ABC Ltd terminated its contract with SG Ltd.
Having read all the board papers in readiness for the meeting, and having spoken to the other directors, you are contemplating what recommendations you will make.
What do you do now?
Analysis of Scenario: What are the readily-identifiable ethical issues for your decision?
I. For you personally
- What are the ethical considerations relating to the proposal to switch from a domestic supplier to an alternative supplier in a developing country which has an unstable political environment?
- Can the Chief Executive be objective in this decision as he has a clear conflict of interest due to his and his family’s financial interest in Company XYZ?
- As chairman, what will you advise the Board to do?
II. For the Company
- Does the company have a set of ethical values which it can refer to when faced with difficult dilemmas such as this?
- The company will have complied with the legal terms of the grant it received but is there a wider duty to be considered?
- Is the company willing to accept the risks associated with dealing with a supplier which is located in a country which has an unstable political environment?
- Is the company willing to accept the political negative media coverage that might result if it terminates the contract with a local supplier?
III. Who are the key parties who can influence, or will be affected by, your decision?
You; the Chief Executive; the other directors of ABC Ltd; the employees of the various companies; the shareholders of ABC; the directors and shareholders of SG Ltd; the directors and shareholders of XYZ; the local enterprise agency; and the local community.
IV. What fundamental ethical principles for accountants are most applicable and is there an apparent conflict between them?
- Integrity: The need for you to give balanced consideration to the likely impact on ABC Ltd of changing/not changing suppliers. Does your company have a clearly defined set of corporate values? If so, where do CSR type issues fit into these? How do you deal with the Chief Executive’s financial interest in the potential supplier?
- Objectivity: The need to objectively balance all the pros and cons of the decision, taking account of the longer-term and not just the shorter-term issues. Are the other members of the board able to be objective on this matter?
- Professional behaviour: The need to explain your recommendation and allow the other board members to fully understand the ramifications of their decision.
V. Is there any further information (including legal obligations) or discussion that might be relevant?
- Does your company have a set of values/Code of Conduct which may have a bearing on your decision?
- Are there any other options open to the company in relation to potential cost savings?
- If the contract was awarded to XYZ, would ABC Ltd have a back-up plan if any future political unrest hindered the supply of raw materials?
- Are there any international embargos on trading with companies in the developing country?
- Would transacting with a company in the developing country expose the company to foreign currency risk that could not easily be mitigated?
- What other suggestions for reducing the company’s cost base have been received from board members?
VI. Is there a conflict between the ‘Guardian’ and ‘Commercial’ strands of an accountant’s responsibilities?
If the FD is falsifying the quarterly management accounts then he is bowing to the commercial pressure to ensure that ABC Ltd is satisfying the funding conditions placed on it by the bank. If the bank covenant terms were breached, the bank could of course take action and the risk would be that ABC Ltd might be put out of business if the funding package was withdrawn or not renewed. The requirements of the ‘Guardian’ role are for the accountant to ensure that the monthly management accounts are a fair representation of the company’s financial performance and position.
VII. Based on the information available, is there scope for an imaginative solution?
Is there any scope for negotiating a price reduction with your existing supplier, SG Ltd? Could some, but not all of the raw material supplies be switched to a different supplier?
VIII. Are there any other comments?
This case study was published by the Technical Policy Board of The Institute of Chartered Accountants of Scotland (ICAS), and adapted by the Institute of Singapore Chartered Accountants (ISCA) with the permission of ICAS.
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