By Denise Lugo
Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP have jointly asked the FASB to clarify the presentation and disclosure rules of trade payable arrangements made in supplier finance programs, a process that enables buyers to optimize their working capital and suppliers to generate additional operating cash flow thereby minimizing risk across a supply chain.
The big four firms, in a joint October 2, 2019, letter, said there are no disclosure rules under GAAP on the topic, and investors need better information than what is currently being provided so they can make informed business decisions.
“We believe that with proper disclosure and explicit statement of cash flow classification guidance, financial statement users will have a better basis for making informed decisions with respect to the company’s financial position, liquidity, and cash flows,” they stated.
The companies asked the FASB to provide 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 Topic 230, Statement of Cash Flows.
Supplier finance is also known as structured trade payables, reverse factoring, vendor payable programs and supply-chain financing. They typically involve a financial institution or other intermediary settling amounts owned to a company’s suppliers of goods or services and the company settling its associated payment obligations directly with the intermediary.
The nature and terms of the programs vary. They include open account platforms that permit a company’s suppliers to elect to sell trade receivables to participating intermediaries and a company’s issuance of negotiable instruments. For example, bills of exchange or electronic time drafts to settle invoices.
In recent years there has been 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, the big four firms said.
Investors Need Better Understanding of Companies’ Obligations
The lack of disclosure rules have placed pressure on companies to properly classify structured trade payable arrangements as trade payables or debt in the balance sheet “in order for financial statement users to understand the nature of the entity’s obligations,” the big four firms said.
“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,” they explained. Greater transparency and consistency in disclosures in the financial statements of entities that utilize structured trade payable arrangements is therefore warranted, they said.
Because of the varying nature and substance of the arrangements, along with the evolving practices and programs involving supplier financing, the companies said they believe it would be difficult for the FASB to provide prescriptive guidance as to the proper classification of such arrangements in companies balance sheets (i.e., trade payable or debt).
They suggested the board require companies to disclose, in relation to structured trade payable programs: a description of the nature and terms of the arrangement; the monetary amounts settled through the arrangement and amounts due for payables the company understands have been sold; and the classification of amounts under the arrangement on the balance sheet and statement of cash flows.
Moreover, they suggested three potential approaches for presentation requirements in the statement of cash flows: present the activities associated with such arrangements gross within the statement of cash flows; present the activities associated with obligations incurred during the period that have been paid by an intermediary, but not yet paid by the entity, as a noncash financing activity; present the cash flows associated with these arrangements within operating activities.
SEC and Ratings Agencies Seeking Transparency
The issue has come under the attention of SEC staff members and ratings agencies. SEC staff recently sent comment letters to registrants to better understand quantitative and qualitative characteristics of such arrangements including:
- 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 Topic 230; and
- the arrangement’s impact on an entity’s payment terms to its suppliers, days of payable outstanding, liquidity and risk factors.
Ratings agencies have called for greater transparency with respect to such arrangements. “Such stakeholders have indicated that whether or not these arrangements are classified as trade payables or borrowings on the balance sheet is less important than sufficient disclosure as to the nature, significant terms and quantitative measure of these arrangements,” the letter states.
The accounting firms suggested that the FASB “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.”
This article originally appeared in Accounting & Compliance Alert, available on Checkpoint.
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