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. Currently, there are 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.” In December, the FASB announced that it had issued a proposed Accounting Standards Update intended to help investors and others “better consider the effect of supplier finance programs on a buyer’s working capital, liquidity, and cash flows.” The proposed ASU would require the buyer in a supply chain financing program to “disclose sufficient information about the program to allow an investor to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude.” On Wednesday, the FASB finalized the details of the plan and gave the go-ahead to draft a final ASU (which is expected to be available later this year) for vote by written ballot. The new ASU would apply to both public and private companies. Although the final ASU has not yet been issued and is still subject to a final vote, companies with supply chain financing programs may want to take note of this anticipated new requirement now. According to Bloomberg, there “will be a shorter turnaround than usual for complying with new FASB requirements”; compliance will be required retrospectively for fiscal years beginning after December 15, 2022, i.e., the first quarter of 2023.
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.’” As described by a member of the FASB, these programs allow payment terms to be extended and can distort cash flow trends, potentially leading to a sudden deterioration of credit quality, in which event, the banks pull the program and there is a “liquidity event.”
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.”
And 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 is absent, and consider adoption of a line-item disclosure requirement. (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, the FASB issued a proposed ASU for public comment. According to the FASB, investors and analysts wanted more transparency about supplier finance programs so that they could “better understand the potential risk of the longer payment terms with suppliers and sources of working capital.” As described by the FASB, in a typical supplier finance program, the buyer “(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 FASB also later noted that typically 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 is neither involved in negotiating nor is legally a party to.” The FASB decided that, while not determinative, “a buyer’s commitment to pay certain invoices to a third-party intermediary would be an indicator that a supplier finance program may have been established.”
The proposal required disclosure of qualitative and quantitative information about the program in the notes to financial statements that would be “sufficient to allow a user to understand the nature, activity during the period, changes from period to period, and potential magnitude of the program.” Under the proposal, the buyer would need to provide a description of the program, disclose the amount of the obligation outstanding and provide a “rollforward” of those obligations. According to the WSJ, 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.” The FASB handout 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.
In a meeting this week, the FASB “completed its redeliberations on the proposed ASU,” voting on several decision points, and directed the staff to draft the final ASU Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations, for vote by written ballot. According to the WSJ, the FASB “expects to issue the new standard sometime this fall.” The FASB tentatively decided that the new rule will require companies to provide disclosure of the outstanding balance of their financing programs every quarter and that it should be applied retrospectively for all periods in which a balance sheet is presented. Compliance will be required for quarterly periods beginning after December 15, 2022, including interim periods within those fiscal years, that is, beginning with the first quarter of 2023.
In addition, the FASB voted to impose a principles-based requirement to describe the program. More specifically, companies will be required to “disclose information about the key terms of a supplier finance program, including a general description of the payment terms (including payment timing and basis for its determination) and the assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary.” The information regarding the key terms of the programs should be disclosed during the year of adoption, when the amount of the obligation outstanding is disclosed in the first interim period.
Companies will also need to disclose annually a “rollforward” amount prospectively for fiscal years beginning after December 15, 2023. The rollforward would show the amount of obligations outstanding 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 obligations outstanding at the end of the reporting period. According to the WSJ, the FASB believes that the rollforward data “will help investors or anyone perusing a financial statement grasp the magnitude of the program and better analyze companies’ cash flows.” If a company has multiple programs, it would be permitted to aggregate disclosures, so long as the aggregation doesn’t obscure useful information about programs with substantially different characteristics. Bloomberg reports that the FASB’s action applies only “to disclosures. The board did not tackle how to recognize and measure supply chain financing arrangements.”
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