PETER JACOBSTEIN, Chief Strategic Partnership Officer, The Interface Financial Group
March 23, 2023
In September 2022, FASB issued ASU-2022-04, with new
disclosure rules for Buyers who offer Supply Chain Finance programs to their
Suppliers. In this report, we’ll examine the new rules, explain when disclosure
is required, and discuss their potential impact on Supply Chain Finance.
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Background
Supply Chain Finance (SCF) has grown dramatically, with global 2022 volume approaching $2.2 trillion according to BCR Publishing’s World Supply Chain Finance Report 2022.
But that growth has not always been smooth. Among others, two major corporate bankruptcies were linked to SCF programs – Abengoa S.A. and Carillion PLC. The failure of UK-based SCF provider Greensill likewise attracted much attention, though the firm’s downfall appears to have ultimately been related to fraudulent activity.
Against the backdrop of these events, investors and analysts began to clamor for greater transparency into buyer SCF programs. And in 2019, the FASB board formally took up the question of SCF accounting treatment. Over the course of the next three years, FASB considered options, took public comment, and developed the standard that they released in 2022.
What FASB Decided
FASB’s first task was to define scope. It created a three-part test and stated that a Supplier Finance Program, subject to disclosure requirements, must meet all these criteria:
- Buyer enters into an agreement with a finance provider or an intermediary.
- Buyer confirms supplier invoices as valid to the finance provider or intermediary under the agreement described in (A).
- Buyer’s supplier has the option to request early payment from a party other than the entity for invoices that the entity has confirmed as valid.
What is Confirmation?
The third criteria – requiring a buyer to notify the finance provider that they’ve confirmed invoices as valid – merits further discussion. The intent here is straightforward: the buyer must tell the funder which invoices are valid and therefore eligible for early payment via the SCF program.
In practice, FASB noted two different types of potential confirmation – but also stated that EITHER would subject the buyer to disclosure requirements.
- Positive Confirmation: the buyer explicitly confirms the validity of invoices for the funder or third party.
- Negative Confirmation: the buyer explicitly confirms the non-validity of all or some invoices.
An Important Indicator – The IPU
FASB recognized that confirmation may sometimes fall into a grey area. To help clear up some potential ambiguity, they discuss an “indicator” – which, while not determinative, may be a sign that a program features confirmation that subjects it to disclosure requirements.
FASB describes the indicator as: “the commitment to pay a party other than the supplier for a confirmed invoice without offset, deduction, or any other defenses to payment.” This guarantee of payment is often known in the SCF world as an Irrevocable Payment Undertaking (IPU).
The IPU’s purpose is to reassure a funder that if it pays a buyer’s supplier invoice early, that the buyer will in turn pay the invoice in full and when due. It ensures that the funder will always be whole, but at the cost of limiting the buyer’s flexibility to address its legitimate right to dilution. IPU’s and other guarantees have been common in the world of SCF, but newer programs that eliminate the need for a buyer guarantee are becoming more common. (More on this later).
What Must the Buyer Disclose?
When a buyer operates a Supplier Finance Program as defined by FASB’s 3-part test, it is required to disclose key information about the program in the footnotes to its financials at least annually.
The annual disclosures must include:
- The key terms of the program, including payment terms and assets pledged as security or other forms of guarantees.
- The amount of obligations outstanding at the end of the reporting period that the buyer has confirmed as valid and a description of where those obligations are presented in the balance sheet. (If the obligations are included in more than one line item, the amount in each line item must be disclosed.)
- Roll-forward information for the annual period showing the amount at the beginning of the period, the amount added during the period, the amount settled during the period, and the amount outstanding at the end of the period.
In each interim reporting period, the buyer must disclose the outstanding confirmed amount as of the end of the interim period.
When Do Disclosure Requirements Begin?
Implementation of the new disclosure rules begins quickly. The FASB standard was released in September 2022, and the obligation to disclose began for all fiscal years beginning after December 15, 2022, along with all interim periods therein.
Disclosure of roll-forwards is delayed, and becomes effective for fiscal years beginning December 15, 2023.
Early adoption is permitted.
What’s Excluded?
It’s worthwhile to review items that FASB explicitly excluded in its new standard:
- Reclassification: under the new standards, buyers must disclose their SCF obligations. But FASB does not require reclassification of those obligations from accounts payable to any other part of the balance sheet, including debt.
- Credit Cards: card payments to suppliers are not subject to disclosure rules, “because the description of a program that the Board decided on indicates that the buyer’s agreement with the finance provider results in the supplier being provided with an option to request early payment, whereas a traditional credit card directs the finance provider to pay the supplier.”
- Payment Processing: “Similarly, the Board concluded that payment processing arrangements do not result in an intermediary providing suppliers with an option to request early payment, and therefore they are excluded from the scope of the amendments.”
- Factoring: Factoring was excluded from the disclosure rules because “under those arrangements the buyer is typically not involved in the establishment of the arrangement with the finance provider, including confirmation to the finance provider on the validity of such receivables.”
Winners and Losers
Investors and analysts have long asked for greater transparency into Supplier Finance programs. They feared that a lack of information could mask risks within a corporate buyer’s balance sheet. The need for transparency grew even more urgent as Supply Chain Finance grew from a niche financing tool to a multi-trillion-dollar mainstream practice.
Big winners include ratings agencies like S&P, Fitch, and Moody’s, along with investors and shareholders generally. Banks, non-bank lenders and other debt financing providers likewise benefit from enhance disclosure.
Of course, the increased disclosure requirements come at a cost. Tracking and presenting details about Supplier Finance programs represents a new burden for buyers who offer their suppliers these programs.
It’s worth noting that most, but not all, Supplier Finance programs will be subject to disclosure. For example, IFG’s signature Digital Supply Chain Finance operates differently from other Supplier Finance programs. It does not require the buyer to make any changes to its normal payment processes: no IPU, no extension of terms. Additionally, IFG does does not require the buyer to confirm the validity of invoices with either positive or negative confirmation.
The entire program was built from the ground up to avoid the pitfalls of traditional SCF programs that have generated controversy and attracted regulatory scrutiny. As such, IFG’s DSCF does not fall under the three-part test described by FASB, and is exempt from the new buyer disclosure rules.