Is Supply Chain Finance Constricted by Accounting Rules?

Slide1

Right now, by all non public measures, early pay funded by third parties is not material. Yet. What the market calls Supply Chain Finance is where the supplier is paid early but the money comes from someone other than the buyer. The accounting issue becomes does the buyer keep it as trade payable or should they reclassify as debt. Examples include PrimeRevenue’s multi-bank supply chain finance program or Orbian’s capital market program

Professor ManMohan Sodi, Cass Business School head of Operations and Supply Chain Group, investigated this issue back in 2012 by interviewing four financial organisations; three of the Big 4 auditing firms, one large FTSE 100 retailer, one large FTSE 100 manufacturer and two large corporations about whether accounting implications hinder adoption of supply chain finance and how these organisations are dealing with accounting issues currently.

The paper had some interesting observations:

According to auditing firms, IFRS suggests reclassification of trade payables into borrowings only if there is a substantial difference in the terms of the existing financial liability and the new liability. Auditors argued that these are very judgemental questions and IFRSs guidance is less prescriptive for the measurement of such financial instruments. According to a director at a Big 4 accounting firm, “ If the exchange between existing borrower and lender is substantially different but it doesn’t define what is substantially different. With reference to IAS39,paragraph AG62, terms are substantially different if the discounted present value of cash flows is at least 10% different from the present value of remaining cash flows of original debt. It doesn’t give any guidance and debate around that whether you need to look at quantitative question or qualitative matters.”

What factors contribute to reclassification risk?

The paper had some comment on that as well:

  1. Handling Supplier Default - In pre-shipment supply chain finance arrangements, banks still bear the risk of supplier default. Pre-shipment offerings are based on purchasing orders instead of confirmed invoices; however such arrangements are not attractive.
  2. Dealing with Credit Notes and Returns - In case of damaged goods or incomplete supplies of goods, the supplier issues credit notes to the buyer. However, auditors raised an issue that buyer’s trade payables may not be able to offset the credit notes under supply chain finance programs. We found that few companies have solved this problem by retaining some amount of the payables to offset credit notes by considering previous rejections of supplier’s goods. Buyers are more concerned about managing credit notes under supply chain finance solutions. Some of the buyers in automotive industry believe that handling of credit notes would be complex in supply chain finance solutions thereby some buyers avoid to take benefits such as rebate sharing and extension of payment terms.
  3. Supplier Concerns on Credit Availability -Essentially, the supplier remains unsure about the credit availability. An agreement between buyer and supplier that ensures credit availability to the supplier for a certain period would transfer trade payables into financial liability towards the buyers.

 

IFRS is not clear on supply chain finance arrangements. I personally think it is time to get accounting guidance on these issues, as these Buyer led programs have proven to be a viable form of finance to suppliers.

If you are interested in a more detailed whitepaper - To Reclassify Trade Payables or Not? - Early Pay Programs and their Accounting Treatment, please visit here.

Voices (3)

  1. Wong ST:

    Interesting topic. I would like to explore this update under IFRS 9.

  2. David Gustin:

    Bob, thanks for taking the time to provide some practitioners input to Professor’s Sodi’s work, which did not have the benefit of your universe. As you say, the Auditor has the final say, and I am sure that can change office to office, accounting firm to accounting firm.

  3. Robert Kramer:

    David, good topic. I’ve worked with all of our clients on trade payables accounting over the last 12 years, as well as all four major audit firms, under both IFRS and US GAAP. I’ve also met with the US SEC on this issue. Ultimately it comes down to the buyer’s implementation and buyers should always check with their independent auditors but I’ll cut it down to a few points:

    1. IAS 39 does not suggest that trade payables should be reclassified into borrowings ONLY if there is a substantial difference in the value of the existing liability and the new liability. It states that if there is a substantial difference in the terms then the liability must be reclassified but it is silent on the question of what happens if there is not a substantial difference in the terms. I find that this is often misunderstood.

    2. I think the accounting question is less complicated than it seems. At a high level, the question is, does the buyer’s liability look like a trade payable, considering a trade payable is the byproduct of a commercial agreement negotiated between a buyer and a supplier. I think the biggest issues are:
    a. Are the payment terms negotiated between buyer and supplier or buyer and bank?
    b. Do any obligations flow from buyer to bank?
    c. Does the buyer expect to receive any consideration, financial or otherwise, from the bank?
    d. Is the supplier’s payment term linked to an agreement between the buyer and a bank?

    I agree with the issues you listed and would look at them through the prism of the agreement between the buyer and the bank and the resulting obligations that flow from the buyer to the bank.

    Bob Kramer
    VP Working Capital Solutions
    PrimeRevenue, Inc.

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