The U.S. accounting standard-setter’s recent decision to make changes to the disclosure of supplier finance program obligations, also known as reverse factoring, “is a much-needed improvement, as there is currently a lack of explicit guidance,” Moody’s Investors Service noted in an accounting spotlight.
This comes as not only credit rating agencies like Moody’s but also other analysts and investors have asked the accounting rule maker, the Financial Accounting Standards Board (FASB), to increase disclosure of qualitative and quantitative information about supplier finance programs. The Big Four accounting firms also requested the board to tackle on aspects of the accounting and disclosure of the programs.
The FASB first issued an exposure draft in December 2021, and on July 20, 2022, decided to adopt revisions to existing rules. The updated standard that requires companies to disclose specified “key terms” will be issued in the fall. Companies that use reverse factoring must start to disclose the extra information, including payment terms, starting from Jan. 1, 2023.
“The expediency of this standard’s effective date is credit positive and a significant win for investors currently struggling to use existing financial statements to understand if supplier finance programs present liquidity risks,” according to Moody’s Sector Comment published on July 25, 2022. It is written by David Gonzales, vice president – senior accounting analyst, who is a member of the FASB’s Financial Accounting Standards Advisory Council and Alastair Drake, senior vice president – senior accounting analyst.
The final standard requires disclosure of a general description of the payment terms, including payment timing and any assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary.
Moreover, companies must present full annual roll-forward information for the programs.
The FASB decided to make some improvements to the proposal in response to feedback, including a March comment letter by Moody’s.
Under the proposal, companies would be able to choose what are considered key terms. This meant that it would be difficult for analysts to properly evaluate the information as the terms would be inconsistently used by companies.
While the board was working on the disclosure rule in the spring, Jeffrey Mahoney, general counsel of the Council of Institutional Investors (CII), said on Aug. 2 that he also had a couple of suggestions.
Mahoney at the time suggested that the FASB require quarterly disclosures. He also suggested that the board require disclosure of the “key terms of the program, including information about the program’s extended payment terms, provided in sufficient detail to understand the impact of the program on the balance sheet line item or items in which the obligations are presented and disclosed.”
In response to feedback from investors and analysts, the FASB took a few steps to improve the proposed rules, especially with the inclusion of key terms. The board in June also decided to require quarterly disclosure of outstanding amounts still owed.
More Improvement Needed?
While Moody’s generally support the final standard, the analysts said that it is still likely to have shortcomings, which they noted in a comment letter to the FASB in March in response to the December 2021 proposal.
“As we have previously stated and illustrated, the risk of a supplier finance program can only be fully understood in relation to the original invoices,” Moody’s analysts wrote.
The FASB does not require the information related to original investors. But they pointed out that international accounting standards-setter, the International Accounting Standards Board’s (IASB) proposal on supplier finance arrangements require such information.
The U.S. accounting rulemaking also does not require companies to disclose the carrying amount for while suppliers have already received payment from the finance providers.
“Without this information, investors cannot fully understand the programs’ contribution to operating cash flow or debt-like classification,” Moody’s wrote. “However, to the FASB’s credit, starting in early 2023, investors will at least know which companies have supplier finance arrangements and how large they are, and will be armed with the tools to ask targeted questions directly to companies.”
This article originally appeared in the August 3, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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