For more than two years, staff and advisory committees, credit rating agencies, investors, the Big Four accountancy firms, and other interested parties have been making noise about a popular funding method called “supply chain finance.” It can be quite a useful financing tool in good hands – companies with good balance sheets. But it can also mask shaky credit conditions and allow companies to delve deeper into debt, often without investors and analysts knowing, sometimes with disastrous ends. Currently, there are no explicit GAAP disclosure requirements to provide transparency about a company’s use of supply chain financing. This may be the reason Bloomberg He referred to supply chain financing as “hidden debt.” Late last month, the Financial Accounting Standards Board (FASB) announced it had released a proposed update to accounting standards aimed at helping investors and others “to better think about the impact of supplier financing programs on buyer’s working capital, liquidity and cash flow.” The proposed ASU would require the purchaser of a supply chain finance program to “disclose sufficient information about the program to allow the investor to understand the nature of the program, its activity during the period, changes from one period to another, and the potential scale.” The comment period will be open until March 21, 2022.
Supply chain finance (sometimes referred to as “supplier financing programs” or “reverse factoring”) involves a company arranging for a bank or other financial intermediary to pay the company’s suppliers on its behalf. according to Bloomberg, businesses “like supply chain financing because it allows them to bill their own and free up cash for other purposes. Suppliers love software too, because a third-party financing provider guarantees payment, often much earlier than they receive from the customer. Arrangements allow suppliers to submit invoices to the financial intermediary. , who pays the invoice at a price slightly less than the full value of the invoice. The financial institution then collects the full amount of the invoice from the company at a later date, taking advantage of the difference.”
As discussed in this Bloomberg article, companies that are “well-capitalized” and operate their programs effectively get “high scores” when they use these programs: “Suppliers get paid, banks get fees, and companies have more time to pay their bills. Companies get a bonus: Payment terms Extended means better looking cash flows.” But when companies’ financial situations are more dire, overuse of this technology can be a problem, especially if it is not fully disclosed. According to one commentator,[w]This is where it starts to get surprising, as the companies that have been involved in this report huge improvements in cash flows that may not be sustainable…and they don’t explain to their investors why. One example in 2018 saw the collapse of a company using supplier financing programmes, which “allowed it to classify nearly half a billion pounds of debt as “other payables”. As described by a member of the Financial Accounting Standards Board, these programs allow payment terms to be extended and can distort cash flow trends, which can lead to a sudden deterioration in credit quality, in which case banks withdraw the program and there is a “liquidity event.”
As noted above, the SEC has urged companies to increase transparency regarding supply chain financing arrangements. In 2019, Corp Fin’s deputy chief accountant said in remarks to the AICPA, which was reported by BloombergNote that there has been an increase in the number of companies using supplier financing programs to “increase liquidity but no corresponding increase in communication with investors about how transactions work”. However, that should be changed: “If they are material to your current term or reasonably likely to materially affect future liquidity, these are things we would expect the Registrar to disclose.” As reported, it urged companies “to communicate whether the increase in operating cash flows are sustainable, trends in terms of payment, and whether they need to extend or enter into more supplier financing programmes.” The Securities and Exchange Commission has used the review and comment process to demand more disclosure from a number of companies. For example, SEC employees asked companies about increases in the length of their accounts payable tenures and why the amounts were classified as accounts payable rather than bank financing. Employee comments also asked companies to disclose the terms of their supplier financing programmes.
In October 2019, as these programs became increasingly popular, the Big Four submitted a letter to the Financial Accounting Standards Board requesting guidance “regarding (i) the disclosures of financial statements that entities that have entered into supplier financing programs that include their trade payables and (ii) Presentation of cash flows related to these programs under International Accounting Standards (ASC) Subject 230, Statement of Cash Flows.” In particular, the four companies noted that, despite developing some practices, “there are no specific guidelines in US GAAP that address Classify these programs as payables or debts…”
At a meeting of the SEC’s Investor Advisory Committee in May 2020, the committee made recommendations to the Securities and Exchange Commission to closely monitor supply chain finance practice. To the committee, the technique looked more like a debt arrangement that should be reflected in balance sheets and in the statement of cash flows, but under current accounting guidance, accounting is left to corporate discretion. According to the commission, supplier financing programs may mask a company’s financial position, affect key performance ratios and increase financial risk, particularly in light of COVID-19-related disruptions in supply chain and financing relationships. But the committee argued that the current disclosure is insufficient. The Committee recommended that the Securities and Exchange Commission (SEC) closely monitor accounting developments relating to this matter, review the MD&A disclosures, make an inquiry in the absence of a disclosure, and consider adopting an item disclosure requirement. (See this PubCo post.)
In June 2020, Corp Fin employees issued Disclosure Guidelines: Topic 9a, which complements CF Topic 9 with additional employee opinions regarding disclosures related to operations, liquidity, and capital resources that companies should consider as a result of business and market disruptions resulting from COVID-19. . Employees note that many companies have had to engage in new financing activities, including supplier financing programmes, some of which may include new terms and structures. The employees advised companies to “make strong and transparent disclosures about how they handle short- and long-term liquidity and financing risks in the current economic environment, particularly to the extent that efforts present new risks or uncertainties to their business.” To help companies assess their disclosure obligations, employees suggested that companies consider the following questions related to supply chain finance:
“Do you rely on supplier financing programmes, otherwise referred to as supply chain financing, structured trade receivables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, or statement of flows? Cash, short and long-term liquidity and, if so, how What are the physical terms of the arrangements Have you or any of your affiliates provided guarantees related to these programs Do you run a physical risk if one of the parties to the agreement terminates it What amounts are owed Payment at the end of the period and related to these arrangements, and what part of these amounts has the broker already settled for you?”
Staff here note that supplier financing programs can vary widely and often include financial institutions as intermediaries. For these types of programs, companies will need to determine the appropriate balance sheet and cash flow classifications for obligations under the programs, which may also affect how programs are discussed in MD&A. (See this PubCo post.)
FASB’s proposed ASU aims to enhance the transparency of supplier financing programs by requiring the purchaser to “disclose sufficient information about the program to allow the investor to understand the nature of the program, its activity during the period, changes from one period to another, and the potential scale.”
As described by the Financial Accounting Standards Board, in a Model Supplier Financing Program, “(1) the purchaser enters into an agreement with a financing provider or intermediary to establish the program, (2) purchases goods and services from suppliers with a promise of payment against a future date, and (3) notifies the financier or the intermediary with supplier invoices that he has confirmed to be valid. Suppliers may then request early payment from the financier or intermediary for those confirmed invoices.” The Financial Accounting Standards Board later also notes that “early payment transactions between the supplier and the financier or intermediary are subject to an agreement between those parties that the buyer understands will arise but are not involved in, and is not a legal party to, the negotiation.” The Financial Accounting Standards Board (FASB) has determined that, while not conclusive, “a buyer’s obligation to pay certain invoices to a third-party intermediary would be an indication that a supplier financing program might be established.”
The Financial Accounting Standards Board notes that investors and analysts want more transparency around supplier financing programs so they can “better understand the potential risks of longer payment terms with suppliers and sources of working capital.” The proposal would require disclosure of qualitative and quantitative information about the Program in the notes to the financial statements which would be “sufficient to allow the user to understand the nature and activity during the period, changes from period to period, and the potential size of the Program.” Qualitatively, the purchaser would need to disclose the key terms of the program and a description of where to offer This amount is on the balance sheet. Quantitatively, the buyer will be required to disclose the amount of the obligation that the buyer has confirmed to be true and remains due and not paid by the buyer as of the end of the period, along with changes during the period. More specifically, disclosures will include an “extension” of those liabilities that show the amount of the liability owed at the beginning of the reporting period, the amount added to the program during the reporting period, the amount settled during the reporting period, and the amount of those liabilities outstanding at the end of the reporting period by the report. To improve the comparability of financial information, the Financial Accounting Standards Board has determined that, in initial application, the proposed adjustments should be applied retrospectively to each period in which the balance sheet is presented. If a company has multiple programs, it will be allowed to aggregate disclosures, as long as the grouping does not obscure useful information about programs with substantially different characteristics. Collectively, the Financial Accounting Standards Board believes that these disclosures should “provide investors and analysts with information relevant to their analyzes of working capital, liquidity, and cash flows.”
The Financial Accounting Standards Board, with three opponents, decided not to request information about the amount due and confirmed in interim periods. However, the proposed ASU asks whether, in addition to annual periods, the company should be “required to disclose the certain amount owed and roll those liabilities in each interim reporting period,” or only for interim reporting periods when there is a significant event or transaction Related to programs that have a material impact on the company. Additionally, the Financial Accounting Standards Board said that because it did not find widespread diversity in practice, it “considered but decided not to address the cash flow statement presentation for changes in obligations covered by supplier financing programs.”