Due to new standards issued by the Financial Accounting Standards Board (FASB) in late 2022, companies with supply chain financing are now required to comply with additional disclosures intended to monitor and understand the effect of supply chain financing programs on a company’s liquidity and cash flows over time. The new requirement, effective in 2023, responds to investor, accounting, and regulatory concerns calling for increased financial statement transparency.
As supply chain financing continues to receive increased scrutiny from investors, accountants, and regulators, companies with these programs will need to consider the methods used to report the qualitative and quantitative information on any reverse factoring arrangements going forward.
Accounting Standards Update No. 2022-04
In September 2022, FASB issued new standards in Accounting Standards Update (ASU) No. 2022-04, Liabilities-Supplier Finance Programs (Subtopic 405-50), which require companies to disclose their supplier finance, or reverse factoring, obligations.
To illustrate these programs, take a supplier that sells goods to a company under a supplier contract. The company owes payment to the supplier for those goods within a certain amount of time, usually between 30 and 120 days, depending on the payment arrangement between the company and supplier.
The company then engages a financial institution, such as a bank or lender, to put in place a reverse factoring program. The company and the bank approach the company’s suppliers and ask if they would like to participate in the program, under which the supplier would sell, and the financial institution would purchase, the accounts receivable of the company held by the supplier arising under the supplier contract.
The supplier accepts a discounted payment from the bank, as the purchase price for the accounts receivable, in exchange for quicker payment by the bank as compared to payment by the company under the supplier contract. At a later date, the company will then pay funds to the bank to settle the invoice.
As a result of a supplier finance program, the company effectively increases its short-term liquidity by retaining its cash, which it can then use in other areas of its business or operations, until the company later pays the financial institution on the invoice that it purchased from the supplier.
These “supply chain solutions” are designed to improve a company’s working capital by extending its “days payable outstanding” (or DPO, meaning the average number of days a company takes to pay invoices for goods and services obtained on credit from its suppliers) by 30 to 60 days. The company gains additional free working capital for the company, and suppliers receive payment more quickly.
The accounting standards update follows increased scrutiny of these arrangements in recent years, with the Securities and Exchange Commission (SEC), accounting firms, and investors asking for more information and guidance about reverse factoring. The SEC, through disclosure guidance, comment letters, and remarks by its Chief Accountant in the Division of Corporation Finance, has urged businesses to disclose any reverse factoring arrangements in the Management’s Discussion and Analysis section of regulatory filings. After FASB proposed the standards for public comment, it moved forward with issuing the standards update with the goal of increasing transparency around supplier finance programs.
FASB’s new standards go into effect for fiscal years ending after December 15, 2022, including the interim quarterly periods ending within those fiscal years. The standards apply retrospectively to each period in which a balance sheet is presented. The exception is the standard on “rollforward” information, as detailed below, which is effective for fiscal years after December 15, 2023 and applies prospectively.
New Obligations for Companies
To summarize the new standards, companies now must report “qualitative and quantitative information” about their reverse factoring arrangements in each annual reporting period. Such information includes
- the key terms of the arrangements, including a description of the payment terms, payment timing, and the basis for determining that timing,
- assets pledged as security and other forms of guarantees provided as credit support for the company’s committed payment to the finance provider or intermediary,
- a description of where in the balance sheet the obligations are presented, and
- the “rollforward” amount of obligations during the annual period, including the amount of obligations confirmed and the amount of obligations subsequently paid (i.e., the amount of the company’s payment obligations to its supplier that the company deferred from their original due date to a later date after the suppliers sold those payment obligations to the financial institution).
Companies must also share their outstanding balance of obligations each interim reporting period as well as how this balance changes from one period to the next.
Findings from Received Disclosures
Several companies have disclosed their reverse factoring arrangements since the standards went into effect. Among the disclosing companies, some report reverse factoring programs that constitute a majority of their total money due to suppliers, whereas some report these programs as a small percentage of their overall accounts payable.
Companies also differ in how much information they disclose about these programs—some companies report the existence of supplier finance programs in their periodic reports along with the related financial metrics, while some others have only disclosed that they have these arrangements and that the outstanding payment obligations under them are not material to the company’s financial statements.
Some investors have expressed concerns that the mandated disclosures are not adequate to properly assess a company’s arrangements. Concerns have included that there is not enough specificity in the new disclosures, that there is a lack of consistent information on the programs, and that the requirements do not provide enough information to be entirely useful in understanding the reverse factoring arrangements beyond prompting more direct questions to the companies.
Companies with these programs will have to consider the manner in which they report the qualitative and quantitative information on any reverse factoring arrangements. Per FASB, an entity can determine the level of disclosure necessary to enhance transparency of their use of reverse factoring programs—for example, a company can aggregate its disclosures if it uses more than one reverse factoring program so long as such programs do not have substantially different characteristics.
Disclosure should support the goal of allowing a user of a company’s financial statement to understand the nature and magnitude of a company’s reverse factoring programs, including activity during the period and changes from one period to the next.
Companies with supply chain financing should think about reverse factoring programs more carefully and holistically, alongside their other debt financing arrangements. As supply chain financing continues to receive more attention from investors, accountants, and regulators, companies should include the programs in their normal reporting and treasury processes.
While FASB’s new standards do require companies to comply with some additional disclosures, the requirement responds to investor, accounting, and regulatory concerns in a manner that can be useful to these stakeholders and increase financial statement transparency while still providing a company with sufficient flexibility to determine what disclosure makes the most sense for its specific facts and circumstances.
Summer associate Laura Hinnenkamp contributed to this Insight.