What are the FRC’s specific concerns and how can you approach these?
The Financial Reporting Council’s attention is set to turn towards supplier financing this next reporting season. Its renewed focus reflects growing concerns about the way some companies are accounting for, and disclosing, their supplier financing arrangements, such as reverse factoring.
What are the FRC’s specific concerns?
The FRC’s spotlight falls on companies that use banks or other financial providers to pay suppliers, before repaying that money to the bank at a later date. It’s a practice that has become a key component of some company’s working capital management.
The FRC’s concern with these arrangements is the extent to which companies appropriately classify creditors on their balance sheet and also how the subsequent cash paid to financial providers is presented in its statement of cash flows.
Companies will need to think even more closely about how they disclose such arrangements when these arrangements become material (either quantitatively or qualitatively), including in five key areas of their corporate reporting:
1. Strategic report
Investors rely on a company’s strategic report to give a fair review of the business, including a balanced and comprehensive analysis of its position at year end. Providing information about the effect of supplier financing facilities on working capital, net debt and cash flows may be relevant to achieving that fair review.
2. Accounting policies
Companies should consider the disclosure of any significant accounting policies and related judgements that have the most significant effect on the presentation of liabilities and cash flows related to supplier financing facilities. This may include the approach to the classification of cash flows as operating or financing (see below).
3. Balance sheet classification and disaggregation
In some cases, a reverse factoring arrangement may mean that the company derecognises the original trade payable and instead recognises a new financial liability to the bank. In other cases, the company will not derecognise the original trade payable.
Regardless of whether the original trade payable is derecognised, a company should think about whether it should adapt the way it presents its liabilities related to supplier finance arrangements in the statement of financial position and notes. That includes potentially adapting headings and line items to suit the particular circumstances. For example:
• Reclassify amounts to a different line, for example within 'other financial liabilities'; or
• Present an additional line item (e.g. supplier factoring facility) either on the face of the statement of financial position or by disaggregation of amounts that have a different nature or function in the related notes.
4. Presentation of cash flows
Reverse factoring arrangements may take different legal forms and structures. In our view, the following approaches to presenting cash flows are acceptable and should be applied consistently.
• Approach 1: Present a single operating cash outflow or a single financing cash outflow for the payments made to the factor.
Under this approach, the company applies judgement to determine whether cash payments made to the factor are classified as an operating or financing cash outflow. That judgement reflects the principle that cash flows are classified according to the nature of the activity to which they relate.
For example, a company should consider whether the principal business purpose of the supplier finance arrangement is to provide funding to the supplier, or to facilitate efficient payment processing. It should also think about whether the reverse factoring arrangement significantly extends payment terms beyond the normal terms it has agreed with other suppliers. In our experience, companies will usually be making cash payments for goods and services as part of their operating activities.
Under this approach, the bank’s payment to a supplier isn’t seen as a cash transaction by the company – i.e. the company presents a single cash flow for its cash payments to the bank, classified as operating or financing. If an entity follows this approach, it might be appropriate to disclose non-cash transactions.
• Approach 2: Present gross cash flows
Under this approach, the company presents financing cash inflows and operating cash outflows when the bank makes a payment to the supplier for the purchase of goods or services by the entity, together with a financing cash outflow for settlement of amounts due to the bank. This approach presents payments by the bank to suppliers as payments made on behalf of the company.
5. Liquidity risk disclosures
Financial statements should include information that allows readers to understand the nature of, and risks around, financial instruments, including liquidity risk. The continued availability of bank facilities, including supplier financing arrangements, may be subject to conditions (for example covenants) that are relevant to an understanding of liquidity risks of the company.
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