United States: The FASB Issues New ASU On Supply Chain Financing Arrangements

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. Moreover, there were 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." But that's about to change. Last week, the FASB announced that it has issued a new Accounting Standards Update that enhances the transparency surrounding the use of supplier finance programs. According to FASB Chair Richard Jones, the "FASB's new ASU responds to requests from investors for greater transparency around a buyer's use of supplier finance programs....It enhances transparency by requiring new disclosures intended to help them better consider the effect of these programs on a company's working capital, liquidity, and cash flows over time." The ASU will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on rollforward information, which has a one-year delay.

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.'"

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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."

In addition, 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 was absent, and consider adoption of a line-item disclosure requirement. (See this PubCo post.) In June 2020, the staff of Corp Fin issued Disclosure Guidance: Topic No. 9A addressing COVID-related business disruptions, in which the staff noted that many companies have been compelled to engage in new financing activities, including supplier finance programs, some of which may involve novel terms and structures. To help companies evaluate their disclosure obligations, the staff suggested that companies consider the following questions regarding supply chain financing: "Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?" (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 2021, the FASB issued a proposed ASU for public comment. According to the FASB, "[o]verall, comment letter respondents and outreach participants supported the Board's efforts to enhance the transparency of supplier finance programs and agreed that the proposed amendments would be decision useful and operable." The WSJ reported that 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." In addition, the FASB 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.

Nevertheless, the FASB concluded that, overall, the "expected benefits of the amendments... justify the expected costs," and, at the end of last week, the FASB issued the new ASU 2022-04—Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. Under the new ASU, a buyer in a supplier finance program will be required to disclose sufficient qualitative and quantitative information about the program "to allow a user of financial statements to understand the program's nature, activity during the period, changes from period to period, and potential magnitude."

As described by the FASB, typically, a buyer in a program "(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 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 generally is neither involved in negotiating nor is legally a party to." Under the ASU, although "not determinative, an indicator that an entity may have a supplier finance program is the commitment to pay a party other than the supplier for a confirmed invoice without offset, deduction, or any other defenses to payment." The FASB determined that the disclosures would not apply to "certain arrangements such as credit cards, payment processing, and normal factoring."

As set forth in the ASU, in each annual reporting period, the buyer should disclose the following information:

According to the ASU, quantitatively, the buyer is "required to disclose the amount of obligations that it had confirmed as valid to a finance provider or an intermediary that is outstanding at the end of the period (the outstanding confirmed amount) and a rollforward of that amount showing the changes from the beginning of the reporting period to the end of the reporting period. Qualitatively, a buyer is required to disclose the key terms of the program and the balance sheet line item in which the outstanding confirmed amount is presented." Under the new rule amendments, companies will be required to provide quantitative disclosure of the outstanding balance of their financing programs every quarter. In addition, information (other than the rollforward) must be applied retrospectively for all periods in which a balance sheet is presented. If a company uses more than one supplier finance program, it may aggregate disclosures, "but not to the extent that useful information is obscured by the aggregation of programs that have substantially different characteristics." The qualitative requirement to describe the key terms of the program in the notes to the financial statements is principles-based, and the identification of the key terms "is a matter of judgment, based upon the facts of the arrangement." The FASB "decided to require that entities disclose a description of the payment terms (including payment timing and the basis for its determination) and any assets pledged as security or other forms of guarantees as key terms." The ASU provides illustrative examples of disclosure of key terms and rollforwards.

The new ASU will require disclosure of the amount of the obligation outstanding for each annual and interim period; however, disclosure of the rollforward, the balance sheet presentation, and key terms will be required only on an annual basis.

As noted above, the new ASU will be effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on rollforward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. During the fiscal year of initial adoption, the information on the key terms of the programs and the balance sheet presentation of the program obligations, which would normally be annual disclosure requirements, should be disclosed in each interim period. In addition, the amendments in the ASU "should be applied retrospectively to each period in which a balance sheet is presented, except for the amendment on rollforward information, which should be applied prospectively."

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