Big Four to FASB: Guidance needed on disclosures of supplier financing arrangements

In their joint letter, dated Oct. 2, Deloitte, EY, PwC, and KPMG have further requested guidance on the presentation of cash flows related to such programs under Accounting Standards Codification Topic 230, Statement of Cash Flows.

These programs go by several names—such as structured trade payables, reverse factoring, vendor payable programs, and supply-chain financing—but all typically involve (1) a financial institution or other intermediary settling amounts owed to an entity’s suppliers of goods or services and (2) the entity settling its associated payment obligations directly with the intermediary.

The nature and terms of the programs vary. They include open account platforms that permit an entity’s suppliers to elect to sell trade receivables to participating intermediaries and an entity’s issuance of negotiable instruments—for example, bills of exchange or electronic time drafts—to settle invoices. In their letter, the Big Four noted that in recent years, they’ve seen “an increase in companies working with intermediaries to arrange trade payable programs and an evolution in the types of such programs that are offered in the marketplace.”

In recent years, these types of programs have evolved, such as concerning the trade payable terms. For example, whereas typical payment terms with suppliers historically might have been 60 to 90 days, some entities today seek to negotiate payment terms with suppliers of up to 180, 210, or even 364 days, they note. “Suppliers are more likely to accept extended payment terms when the purchaser has arranged a structured payable program that permits the suppliers to monetize their trade receivables before its due date,” the Big Four said.

There is no specific guidance in U.S. GAAP that addresses the classification of these programs as trade payables or debt. This lack of specific disclosure requirements in U.S. GAAP related to these types of programs has resulted in limited disclosure of such programs provided in practice.

As a result, pressure is placed on the proper classification of the structured trade payable arrangement as trade payables or debt in the balance sheet in order for investors to understand the nature of the company’s obligations. “Trade payable classification tends to be treated more favorably than borrowings (i.e., financings) in the calculation of financial ratios and for purposes of determining compliance with financial covenants,” the Big Four said in their letter. “Accordingly, we believe greater transparency and consistency in disclosures in the financial statements of entities that utilize structured trade payable arrangements … is warranted.”

SEC and Moody’s weigh in

In recent comment letters to registrants, SEC staff has expressed interest in better understanding quantitative and qualitative characteristics of such arrangements. Specifically, such characteristics include:

• Dollar amounts settled via the arrangement and the balance representative of amounts due to the financial institution/intermediary;
• Analysis supporting classification of amounts settled under the arrangement as trade payables or bank financing, including classification and non-cash disclosure considerations per ASC 230; and
• The arrangement’s impact on an entity’s payment terms to its suppliers, days payable outstanding, liquidity, and risk factors.

Rating agencies also have called for greater transparency with respect to such arrangements. In fact, Moody’s Investors Service said in a new report: “Improved transparency and disclosure is needed for reverse factoring (RF) as few customers reveal their use of this increasingly popular supply chain financing tool, some may not fully understand its risks and investors cannot assess their exposure in the absence of disclosure.”

Reverse factoring—which contributed to the high-profile defaults at Abengoa and Carillion—can “weaken liquidity at a time of stress, with termination of reverse factoring arrangements potentially leading to sudden and significant working capital outflow over a matter of weeks or months,” Moody’s said.

“Users of financial statements may not be aware of a customer’s usage of reverse factoring, despite the potentially material consequences,” said William Coley, an associate managing director at Moody’s. “The customer itself may not fully understand the added risk that accompanies the use of this financing technique.”

In its joint letter, the Big Four said FASB “should perform outreach of a cross-section of users such as lenders and rating agencies to understand their needs regarding differentiation between different categories of short-term payables.”

The Big Four acknowledged in their letter it would be difficult for FASB to provide prescriptive guidance as to the proper classification of such arrangements in an entity’s balance sheet (i.e., trade payable or debt), “given the varying nature and substance of these programs, along with the evolving practices and programs involving supplier financing.”

“However, we believe that with proper disclosure and explicit statement of cash flow classification guidance, users of the financial statements will have a better basis for making informed decisions with respect to the entity’s financial position, liquidity, and cash flows,” the letter continued. “We believe that standard-setting by the Board to provide guidance on the presentation and disclosure of the trade payable arrangements discussed in this agenda request would provide greater transparency to users of entities’ financial statements.”

FASB’s next board meeting takes place Oct. 30.