For several years, the SEC staff and advisory committees, credit
rating agencies, investors, the Big Four accounting firms and other
interested parties have been making noise about a popular financing
technique called “supply chain financing.” It can be a
perfectly useful financing tool in the right hands—companies
with healthy balance sheets. But it can also disguise shaky credit
situations and allow companies to go deeper into debt, often
unbeknownst to investors and analysts, with sometimes disastrous
ends. Moreover, there were no explicit GAAP disclosure requirements
to provide transparency about a company’s use of supply chain
financing. That may be why Bloomberg has referred to supply chain
financing as “hidden debt.” But that’s about to
change. Last week, the FASB announced that it has issued a new Accounting Standards Update that enhances the
transparency surrounding the use of supplier finance programs.
According to FASB Chair Richard Jones, the “FASB’s new ASU
responds to requests from investors for greater transparency around
a buyer’s use of supplier finance programs….It enhances
transparency by requiring new disclosures intended to help them
better consider the effect of these programs on a company’s
working capital, liquidity, and cash flows over time.” The ASU
will be effective for fiscal years beginning after December 15,
2022, including interim periods within those fiscal years, except
for the amendment on rollforward information, which has a one-year
delay.
Supply chain financing (sometimes referred to as “supplier
finance programs” or “reverse factoring”) typically
involves a company arranging for a bank or other financial
intermediary to pay the company’s suppliers on its behalf.
According to the WSJ, “supply-chain financing has
gained popularity as companies stock up on inventory and push their
payment terms out further. The tool allows companies to pay bills
later, while suppliers get their cash more quickly. A third
party—usually a bank—pays the vendor’s invoices,
but takes a cut. The business pays the bank what was due under the
invoice, though at a later date than originally required.” As
discussed in this
Bloomberg article, companies that are “well
capitalized” and run their programs effectively receive
“high marks” on their use of these programs: “The
suppliers get paid, the banks get fees, and the companies have more
time to pay their bills. Companies get a bonus: Extended payment
terms mean better looking cash flows.” But where
companies’ financial situations are more precarious, overuse of
the technique could be problematic, especially if not fully
disclosed. According to one commentator, “[w]here it begins to
raise eyebrows, is where companies that have been engaged in this
are reporting a large improvement in cash flows that may not be
sustainable….And they aren’t highlighting to their investors
why.” One instance in 2018 saw the collapse of a company that
used supplier finance programs, which “allowed it to label
almost half a billion pounds of debt as ‘other
payables.'”
SideBar
As noted above, the SEC has been prodding companies to increase
transparency regarding supply chain financing arrangements. In
2019, the Corp Fin Deputy Chief Accountant, in remarks to the
AICPA, reported by
Bloomberg, observed that there had been an increase in the
number of companies using supplier finance programs “to
increase their liquidity but no corresponding increase in
communication with investors about how the transactions work.”
That, however, needed to change: “‘If they are material to
your current period or are reasonably likely to materially impact
liquidity in the future, these are things we’d expect a
registrant to disclose.'” As reported, she urged
businesses to “convey whether the increase in operating cash
flows is sustainable, trends related to the payment terms, and
whether they need to extend or enter into more supplier finance
programs.”
In addition, the SEC has used the review and comment process to
ask a number of companies for more disclosure. For example, the SEC
staff has
asked companies about increases in the length of their accounts
payable periods and why the amounts were classified as accounts
payable instead of bank financing. Staff comments have also asked
companies to disclose the terms of their supplier finance programs.
At a meeting of the SEC’s Investor Advisory Committee in May
2020, the committee submitted recommendations to the SEC to closely
monitor the practice of supply chain financing, review MD&A
disclosures and make inquiry where disclosure was absent, and
consider adoption of a line-item disclosure requirement. (See this PubCo post.) In June 2020, the staff of
Corp Fin issued Disclosure Guidance: Topic No. 9A addressing
COVID-related business disruptions, in which the staff noted that
many companies have been compelled to engage in new financing
activities, including supplier finance programs, some of which may
involve novel terms and structures. To help companies evaluate
their disclosure obligations, the staff suggested that companies
consider the following questions regarding supply chain financing:
“Are you relying on supplier finance programs, otherwise
referred to as supply chain financing, structured trade payables,
reverse factoring, or vendor financing, to manage your cash flow?
Have these arrangements had a material impact on your balance
sheet, statement of cash flows, or short- and long-term liquidity
and if so, how? What are the material terms of the arrangements?
Did you or any of your subsidiaries provide guarantees related to
these programs? Do you face a material risk if a party to the
arrangement terminates it? What amounts payable at the end of the
period relate to these arrangements, and what portion of these
amounts has an intermediary already settled for you?” (See this PubCo post.)
In October 2019, with the prevalence of these programs
increasing, the Big Four submitted a letter to the FASB requesting guidance
“regarding (1) the financial statement disclosures that should
be provided by entities that have entered into supplier finance
programs involving their trade payables and (2) the presentation of
cash flows related to such programs under Accounting Standards
Codification (ASC) Topic 230, Statement of Cash Flows.” In
particular, the four firms observed that, although some practices
have developed, “there is no specific guidance in U.S. GAAP
that addresses the classification of these programs as trade
payables or debt….”
In December 2021, the FASB issued a proposed ASU for public comment. According to
the FASB, “[o]verall, comment letter respondents and outreach
participants supported the Board’s efforts to enhance the
transparency of supplier finance programs and agreed that the
proposed amendments would be decision useful and operable.”
The WSJ reported that some companies objected
to the proposal as unnecessary because they believed that the
information was calculable from accounts payable on the balance
sheet. Some said that it would be too expensive to implement
properly, requiring an increase in information technology spending.
Some also objected specifically to the rollforward disclosure as
costly, unnecessary, and perhaps not even “representative of
the actual activity under the program.” In addition, the FASB
indicated that objections were also raised by
about a third of respondents to the proposed retrospective approach
for the disclosure requirements, “noting that preparers could
spend significant time and incur significant costs to implement
controls systems and processes to provide the disclosures
required” in the proposed ASU.
Nevertheless, the FASB concluded that, overall, the
“expected benefits of the amendments… justify the expected
costs,” and, at the end of last week, the FASB issued the new
ASU 2022-04—Liabilities—Supplier
Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance
Program Obligations. Under the new ASU, a buyer in a
supplier finance program will be required to disclose sufficient
qualitative and quantitative information about the program “to
allow a user of financial statements to understand the
program’s nature, activity during the period, changes from
period to period, and potential magnitude.”
As described by the FASB, typically, a buyer in a program
“(1) enters into an agreement with a finance provider or an
intermediary to establish the program, (2) purchases goods and
services from suppliers with a promise to pay at a later date, and
(3) notifies the finance provider or intermediary of the supplier
invoices that it has confirmed as valid. Suppliers may then request
early payment from the finance provider or intermediary for those
confirmed invoices. The early payment transactions between the
supplier and the finance provider or intermediary are subject to an
agreement between those parties that the buyer understood would be
established but generally is neither involved in negotiating nor is
legally a party to.” Under the ASU, although “not
determinative, an indicator that an entity may have a supplier
finance program is the commitment to pay a party other than the
supplier for a confirmed invoice without offset, deduction, or any
other defenses to payment.” The FASB determined that the
disclosures would not apply to “certain arrangements such as
credit cards, payment processing, and normal factoring.”
As set forth in the ASU, in each annual reporting period, the
buyer should disclose the following information:
- “The key terms of the program, including, but not limited
to:
- A description of the payment terms, including payment timing
and the basis for its determination - Assets pledged as security or other forms of guarantees
provided for the committed payment to the finance provider or
intermediary….
- A description of the payment terms, including payment timing
- The amount of obligations outstanding at the end of the
reporting period that the entity has confirmed as valid to the
finance provider or intermediary under the program (that is, the
amount of obligations confirmed under the program that remains
unpaid by the entity) and the following information about those
obligations:
- Where those obligations are presented in the balance sheet. If
those obligations are presented in more than one balance sheet line
item, then the entity shall disclose the amount outstanding at the
end of the reporting period in each line item. - A rollforward of those obligations showing, at a minimum, all
the following:
- The amount of those obligations outstanding at the beginning of
the reporting period - The amount of those obligations added to the program during the
reporting period - The amount of those obligations settled during the reporting
period - The amount of those obligations outstanding at the end of the
reporting period….
- The amount of those obligations outstanding at the beginning of
- Where those obligations are presented in the balance sheet. If
In each interim reporting period, an entity shall disclose the
amount of obligations outstanding that the entity has confirmed as
valid to the finance provider or intermediary under the supplier
finance program at the end of the reporting period.”
According to the ASU, quantitatively, the buyer is
“required to disclose the amount of obligations that it had
confirmed as valid to a finance provider or an intermediary that is
outstanding at the end of the period (the outstanding confirmed
amount) and a rollforward of that amount showing the changes from
the beginning of the reporting period to the end of the reporting
period. Qualitatively, a buyer is required to disclose the key
terms of the program and the balance sheet line item in which the
outstanding confirmed amount is presented.” Under the new rule
amendments, companies will be required to provide quantitative
disclosure of the outstanding balance of their financing programs
every quarter. In addition, information (other than the
rollforward) must be applied retrospectively for all
periods in which a balance sheet is presented. If a company uses
more than one supplier finance program, it may aggregate
disclosures, “but not to the extent that useful information is
obscured by the aggregation of programs that have substantially
different characteristics.” The qualitative requirement to
describe the key terms of the program in the notes to the financial
statements is principles-based, and the identification of the key
terms “is a matter of judgment, based upon the facts of the
arrangement.” The FASB “decided to require that entities
disclose a description of the payment terms (including payment
timing and the basis for its determination) and any assets pledged
as security or other forms of guarantees as key terms.” The
ASU provides illustrative examples of disclosure of key terms and
rollforwards.
The new ASU will require disclosure of the amount of the
obligation outstanding for each annual and interim period;
however, disclosure of the rollforward, the balance sheet
presentation, and key terms will be required only on an annual
basis.
As noted above, the new ASU will be effective for fiscal years
beginning after December 15, 2022, including interim periods within
those fiscal years, except for the amendment on rollforward
information, which is effective for fiscal years beginning after
December 15, 2023. Early adoption is permitted. During the fiscal
year of initial adoption, the information on the key terms of the
programs and the balance sheet presentation of the program
obligations, which would normally be annual disclosure
requirements, should be disclosed in each interim period. In
addition, the amendments in the ASU “should be applied
retrospectively to each period in which a balance sheet is
presented, except for the amendment on rollforward information,
which should be applied prospectively.”
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
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