There has been significant media coverage of the use of and disclosures in the financial statements of supplier financing arrangements by Australian corporates. This Reporting Update considers the associated financial reporting issues and disclosure considerations.
In recent months, there has been significant media coverage of the use and disclosure in the financial statements of supplier financing arrangements (or reverse factoring) by Australian corporates.
Supplier financing also known as reverse factoring is an arrangement in which a financing entity, usually referred to as a factor agrees to pay the supplier of goods or services of an entity, the customer, on short payment terms and at a discount, and the customer paying the factor at a later date. Reverse factoring is usually initiated by the customer and the factor, and there is usually a three-party agreement involving the customer, the factor and the supplier.
The focus is on the accounting by the customer.
There are a number of entities offering to finance these arrangements including banks, fintechs and other types of financiers.
Supplier financing allows customers to manage their cash flows. Some of the ways in which this could be achieved is by extending payment terms and deferral of payment beyond the original payment date of the supplier’s invoice. The supplier may still be paid in accordance with its original payment terms, at a discount or at an earlier date by the financier.
It also streamlines the entity’s accounts payable process as the customer typically only has to make a single monthly payment to the factor rather than managing the payment of all the individual supplier’s invoices.
In exchange the factor will receive a fee or commission from the customer.
The issue with these arrangements is determining how the liability and the corresponding cash flows should be classified and presented in the financial statements, and whether there is sufficient disclosure around the terms, risks and uncertainties connected with the arrangement.
Users of financial statements are interested in the nature of these arrangements as they form part of the customer’s liquidity risk management policies, typically resulting in a direct improvement in working capital balances.
In addition, for some entities, the liabilities subject to these arrangements may impact their debt covenants.
There is diversity in practice in accounting for and disclosing the nature of supplier financing arrangements given the lack of specific guidance in accounting standards on these types of transactions.
The following summarises the main considerations from a customer’s perspective.
One of key accounting issues surrounding these arrangements is how this liability should be presented on the balance sheet. AASB 101 Presentation of financial statements does not prescribe the sub captions on the balance sheet. In addition, there is no definition of debt or trade payables in accounting standards. There is only a reference to trade payables in AASB 137 Provisions, Contingent Liabilities and Contingent Assets which states that “trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier”.
Hence the presentation of the amounts is an area of judgement.
Entities should consider whether the nature or amount of the liability subject to supplier financing is different to that of their other trade payables and therefore the amounts would warrant separate presentation on the face of the balance sheet or in the notes.
Some users of financial statements refer to cash flow statements to determine the quality of earnings of an entity. Hence how supplier financing arrangements are disclosed in the cash flow statement may be a focus area for these users.
There is no specific guidance in AASB 107 Statement of Cash Flows on whether the payments in supplier financing arrangements are operating or financing in nature.
Entities should consider whether it is more appropriate to present a single net cash outflow as either operating or financing, or present gross cash flows. If entities adopt a net cash flow approach, they should also consider whether disclosures are required around non-cash transactions, that is, the amount paid by the factor to the supplier is considered to be a non-cash transaction.
Although there is judgement about how the liability and the cash flows subject to these arrangements should be presented on the balance sheet and Statement of Cash Flows, the current heightened level of media interest is a strong indicator that information about these arrangements is relevant to users and therefore is likely to be material.
Entities should include the details of their accounting policies for these arrangements, describing how the arrangement has been reflected on the balance sheet and Statement of Cash Flows and the judgements involved.
In addition, AASB 7 Financial Instruments: disclosures requires entities to include information that enable users of financial statements to evaluate the nature and extent of risks arising from financial instruments. Payables are financial liabilities captured by AASB 7. Therefore supplier financing arrangements are likely to be part of the entity’s management of liquidity risk and therefore they should be included in both their qualitative and quantitative liquidity risk disclosures.
“With heightened market focus on the use of supplier financing arrangements, entities should ensure there is sufficient disclosure in the financial statements”.
Some entities will also have to consider the impact of supplier financing arrangements on their covenants. Such arrangement may be classified as a debt instrument under the covenant conditions and hence increase the risk of a covenant breach. Further complexities arise when the covenants rely on trade payables or debt as defined by the accounting standards as accounting standards do not define these terms.
For example, the debt covenants for indebtedness or gearing ratios may exclude amounts payable to suppliers, or exclude the trade payables as disclosed on the balance sheet but include any amount that is considered debt or borrowing.
In some instances, legal opinion may be required to confirm whether the arrangement falls within the covenant conditions.
If your entity has any types of factoring arrangements and you would like to discuss further, please reach out to your usual KPMG contact.
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