Upcoming reforms to accounting standards will change how supply chain finance programmes are disclosed in financial statements. Jacob Atkins takes a look.
Calls by investors and regulators for more transparency in the way supply chain finance (SCF) programmes are disclosed by companies that use them came to a head last year, with the bodies which set accounting standards across most of the globe putting forward new requirements.
The need for uniformity and guidance on the way buyers report their participation in SCF programmes has been welcomed across the spectrum, although there is a clear divide between users of financial statements, for example investors and professional services firms, and the companies who will be required to make the disclosures, such as large corporations.
Here are five key things to know about the upcoming changes.
1. The new disclosure rules will be global
The bodies in charge of the world’s major sets of accounting standards are adopting changes which aim to make it easier to see when a company is using a payables finance programme to pay its suppliers.
There are two widely-used sets of reporting standards: the International Financial Reporting Standards (IFRS), overseen by the London-based IFRS Foundation, and the US’ generally accepted accounting principles (GAAP), established by the Financial Accounting Standards Board (FASB).
GAAP standards are only used in the US, while the IFRS are the most commonly used standards globally. Large multinational companies, including those with multiple listings, may use both. Some countries, such as China, have their own accounting standards but they often hew closely to the IFRS.
The FASB was first to examine the issue of SCF disclosure, following a letter by the big four accounting firms – KPMG, Deloitte, EY and PricewaterhouseCoopers – which called on the FASB to proffer guidance on the topic, arguing 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”. A couple of months later the firms’ letter won the backing of the Securities and Exchange Commission (SEC), the top US markets regulator.
A few months after that, the IFRS’ standards-setting body, the International Accounting Standards Board (IASB) was also quizzed by the investor services arm of credit rating agency Moody’s on how SCF programmes can be disclosed under its rules.
In December 2020 the IASB decided additional standards specific to supplier finance were not necessary, instead issuing an “agenda decision” which effectively provided guidance to accounting practitioners on how to use existing standards and principles to disclose supplier finance arrangements when preparing financial statements. But just six months later the organisation changed tack, deciding to put forward new standards, a draft of which it published in November 2021. The IASB said it received feedback that the agenda decision “would not meet all investor needs”.
The standards are likely to come into effect sometime this year, after both bodies have incorporated the large volume of feedback received from SCF providers, corporates, accounting bodies and investors.
2. The standards don’t apply to all types of supply chain finance
Both sets of proposals only apply to buyer-led reverse factoring arrangements. In the IASB’s words, the standards are “confined to arrangements that finance amounts an entity owes its suppliers”.
The organisation says it considered promulgating standards encompassing other forms of SCF, such as receivables financing, but decided that “a wider scope might… result in delaying improvements to the required disclosures for supplier finance arrangements, which the board has been informed are needed by investors and analysts”.
Both cases also only concern disclosures required by the buyer in a supplier finance arrangements, not the supplier or finance provider.
Despite the intention to limit the standards to buyers in supplier finance arrangements, many of the responses to the standards, published late last year, include concerns that the characterisation of arrangements that will be in scope is either too narrow and therefore could exclude some relevant programmes, or too broad and may unintentionally capture other types of financing.
“We think there is scope for the proposals to inadvertently capture other finance arrangements, such as supplier-led programmes where a debtor is asked to confirm a receivable, and therefore the proposals could potentially have a negative impact on those types of finance arrangements,” Charles Thain, a partner with law firm Mayer Brown, tells GTR.
It is also possible that one or both bodies will examine the need for standards on other varieties of SCF.
David Gonzales, a senior accounting analyst at Moody’s Investor Services, believes that broader work on standards, or at least better enforcement of existing accounting standards as they apply to SCF scenarios, might be necessary.
These are “standards that are written for… financial institutions, that I think might have a little bit of trouble being applied by more of a traditional company that isn’t in the business of selling financial assets”, he says.
3. Investors worry that payables finance lets companies call debts by another name
Currently, corporates which have a supplier finance arrangement in place typically categorise the flows as accrued liabilities or accounts payable on balance sheets and cash flow statements, according to Gonzales. This makes them appear as cash inflows, when in reality they are a financing arrangement.
“The most difficult thing is that when you look at the financial statements, these appear to be normal operating liabilities and accounts payable that have just been extended… in order to save some working capital and delay cash outflows,” Gonzales tells GTR.
“But in actuality, there’s a financing intermediary that is allowing for the extension of some of these payables, sometimes up until the limit of the payable and sometimes even beyond the payable due date.”
It is important for a reader of a financial statement to know when a payable is owed to a bank or financial intermediary under an SCF arrangement, rather than a company’s supplier, according to Gonzales.
An SCF arrangement between a corporate and a bank may have unique terms and conditions, due dates and afford rights to the financial institution in cases of financial distress or bankruptcy. “When you look at the financial statements, and they look like operating liabilities, you may be missing some of the picture as far as how much influence or power the bank might have,” Gonzales says.
That is also the case if the bank providing the programme decides to axe it. In a scenario where a company’s suppliers have been used to getting paid in 30 days by a bank, and the company is accustomed to paying the bank at 60 days, there is a potential mismatch which may have to be plugged with cash on hand or borrowing. SCF providers have pointed out, however, that there hasn’t yet been a real-world case of a corporate being put under liquidity distress due to the withdrawal of an SCF programme.
The ability to easily identify the existence of a supplier finance programme will be a significant stride forward, according to Martin Lawrence, a director of Ownership Matters, an Australian investment research firm.
Up until now, Lawrence has had to ferret through the fine print of company disclosures and submit questions to firms in order to unearth the existence of SCF programmes – although some companies have proactively disclosed them – but the efforts are not always successful.
He tells GTR: “The investor’s side of the concern is agnostic about whether supply chain finance is good, bad or indifferent – just tell us that you’re using it, please, so we can work out the difference it makes.”
Better disclosure will not only help investors size up specific firms, but will make broader market trends more discernible and give visibility to problems on the horizon, according to Fermat Capital Management, a US firm which manages investments in SCF. Its submission to the FASB says stronger disclosures are needed “to better understand what is happening to balance sheets and the corresponding broader implications for the market”.
“Without additional information about the extent and scope of utilisation of supply chain facilities, the nature of banks that are relied on, the size and scope of credit facilities maintained, and the nature of any short-term funding or solvency issues of specific banks, it is difficult to assess corporate financial condition, let alone the aggregating risk of systemic market events which collectively and separately have significant impacts on creditors, shareholders, suppliers, debtor employees and society at large.”
Representatives of SCF providers and users have mostly agreed with the proposed standards in principle but still see concerns over the risks of SCF as overblown.
The Bankers Association for Finance and Trade (Baft), in its submission to the IASB, says that “the liabilities arising from [supplier finance arrangements] do not create additional financial risk above and beyond those that already exist in trade between a buyer and a seller”.
“The main liquidity risks of the buyer are taken by the finance provider, and negative outcomes can be avoided by implementing strong credit analysis of a buyer’s balance sheet before engaging in an supplier finance arrangement,” says the group, which represents banks.
The International Trade and Forfaiting Association points out in its submission to the IASB that SCF can reduce non-payment risks in a supply chain because a financier is usually better equipped than a supplier to assess the credit risk of a buyer. “Supplier finance programmes typically provide a significant risk mitigant by bringing in third-party liquidity, credit assessment and pricing capacity,” the group says.
4. US companies are likely to face slightly different reporting rules
Both the IASB and FASB proposals share the broadly similar objective of making supplier finance arrangements easy to spot, and potential risks more clearly identifiable.
But there are some differences between the two proposals.
Although the GAAP standards are rules-based, and the IFRS standards are principles-based, it is the latter that experts say are somewhat more prescriptive.
“In terms of the actual disclosure requirements, and noting that we are lawyers and not accountants, it appears that the IASB proposal requires greater disclosure of more granular detail in respect of the relevant arrangements,” says Mayer Brown’s Thain, who co-authored the firm’s submissions to the consultation processes.
Both have characterised supplier finance arrangements (in the IASB parlance), or programmes (as the FASB terms them) slightly differently, “so clearly there is scope for certain arrangements to fall within the ambit of one and not the other”, Thain says.
“Clearly, having different disclosure requirements between the two proposals is less than ideal for both the entity that has to comply with the disclosures and those who are using the entity’s financial statements.”
Another difference is that the IASB’s suggested standards include a requirement to provide information that will allow third parties to understand how the company’s obligations differ under the SCF programme, compared to the original commitments to suppliers.
The IASB’s proposals also include a requirement to show the range of due dates under a supplier finance programme and allow those to be compared to the due dates for other trade payables.
“I think that you’ll get more transparent information from a company that reports under the IASB, especially about this early payment issue,” says Gonzales.
Some submissions to the FASB, including those from the International Chamber of Commerce and accounting giant KPMG, ask the US body to include many of the disclosure requirements being planned by the IASB.
5. Opinions are divided on whether standards will impact SCF usage
Whether the new accounting norms will impact usage of SCF partly depends on the precise wording of the standards, which may change as industry feedback is incorporated.
Lawrence of Ownership Matters believes that the new paradigm may weed out companies that are using supplier finance programmes to improve their books. “If companies were using supply chain finance for commercial reasons, that had nothing to do with debt, then I would imagine this would make no difference on the utilisation [of SCF] or otherwise,” he says. “If they were using it because it’s the type of debt that you don’t need to call debt, then it may well make a difference.”
Thain says: “Assuming FASB and IASB finalise the disclosure requirements in broadly the same form as their proposals, we do not foresee these disclosure requirements impacting the use of these arrangements generally because we expect that most users of these arrangements already disclose their existence to their debt providers; however time will tell.”
But submissions to the standards-setting bodies argue that the precise wording of the standards may make reporting too cumbersome. For example, industry groups such as Baft argue that buyers won’t be able to provide as much information as the IASB standards demand because they may not have access to terms agreed between their suppliers and the SCF provider, and even if they do, disclosing them poses confidentiality risks and could discourage use of SCF programmes.
Some large corporates who have voiced opinions on the proposals say that the reforms, particularly the IASB’s approach, will be challenging for firms to comply with. For example, British American Tobacco wrote in a submission that the IASB’s requirement for firms to disclose details of each supplier finance programme, instead of just in aggregate, is “impractical and would lead to meaningless clutter”.
Nutrien, the Canadian agriculture giant, says a requirement for financial statement preparers to include information on liabilities that have already been paid to suppliers by an SCF provider, “could require contractual changes, increase compliance costs and add considerable burden to the preparation of financial statements”.
