21RU-012 Working capital management: Reporting impacts

Highlights | Supplier financing | Inventory financing | Receivables financing | Credit losses| Download

What are the financial reporting considerations when working capital management activities including supplier, inventory and receivables financing are undertaken? This Reporting Update considers these impacts and provides some action points when considering whether the impacts of working capital management activities are appropriately reflected in the financial report.

• Supplier financing
• Inventory financing
• Receivables financing
•  Managing credit losses – insurance over trade receivables

Many organisations are actively managing their working capital. This includes entering into supplier and inventory financing arrangements, monetising their trade receivables balances and protecting the value of trade receivables by insuring against loss in the event of default.

There are flow-on financial reporting impacts when organisations engage in these types of activities, including the presentation on the balance sheet, income statement and cash flow statement and whether there are sufficient disclosures about the arrangements to ensure that users of financial statements understand the extent and nature of such arrangements.

This Reporting Update considers these financial reporting impacts and provides some action points when considering whether the impacts of working capital management activities are appropriately reflected in the financial report.

Supplier financing or reverse factoring is used by some organisations to manage their working capital. Under these arrangements an organisation enters into an agreement with a financier where the financier agrees to pay the organisation’s suppliers and the organisation will pay the financier at a later date. It also streamlines the organisation’s accounts payable process as the organisation typically only has to make a single monthly payment to the financier rather than managing the payment of all the individual supplier’s invoices.

Financial reporting considerations will include:

• nature of liability on the balance sheet
• presentation in the cash flow statement
• financial risk management disclosures
• impacts on debt covenants.
  

Inventory financing are typically short-term loans used by organisations for purchasing stock or materials that are for sale or used in the production process. They are commonly used where there is a time lag between the purchase and use in the production process or sale. The financier pays the supplier for the products upfront and the organisation repays the financier at a later date. To initiate these arrangements, some organisations may involve the financier during the purchase process with the supplier.

Careful analysis is required to determine whether the financier or the organisation controls the product initially. If the organisation controls the product then it is recognised as inventory with a corresponding liability to the financier. Alternatively, if the financier controls the product, then both the product and liability are ‘off balance sheet’ in the financial statements of the organisation. In this scenario, the organisation will likely only control and recognise the inventory and liability at a later date, closer to use or sale.

In other scenarios, organisations may enter into arrangements with the financier where they agree to ‘sell’ their inventory and to ‘buy’ back at a later date. In such situations, the organisation will need to consider the repurchase guidance in AASB 15 Revenue from Contracts with Customers and whether the organisation has transferred control of the product to the financier.

Financial reporting considerations will include:

• liability classification on balance sheet
• disclosure of collateral.
  

Some organisations factor their receivables portfolio, where they receive funding from a financier upfront, with the agreement to repay the amount when it is received from their customers. One of the key considerations is whether the receivables are derecognised or 'sold' from an accounting perspective. If the transaction does not qualify for derecognition, the transaction is recognised as a funding arrangement, with a liability recognised for the amount received.

The analysis to determine when financial assets, including trade receivables, are derecognised is complex. The primary question is whether the organisation has transferred substantially all risks and rewards of the trade receivables to the financier. For short-term receivables, this means determining whether, as a result of the ‘sale’ to the financier, the organisation is either no longer exposed to a risk of loss from a customer failing to pay, or if it is still exposed, its exposure is reduced substantially.

Financial reporting considerations will include:

• liability classification on balance sheet
• disclosure of collateral.

Some organisations may also insure the collectability of their trade receivables. That is, the insurer compensates the organisation if its customers default and it suffers a loss. Given the current global economic environment, there is a risk that insurance over receivables may not be renewed when policies expire. This may present a significant business risk to some organisations, for example, where their margins are slim, although the financial reporting implications are limited.

Financial reporting considerations will include:

• impact on expected credit loss calculations
• disclosure of credit enhancement.