Supply chain financing (SCF) is a funding solution that uses innovative technologies to help manage cash flows and address liquidity constraints insu international trade. The World Trade Organization (WTO) estimates that between 80% and 90% of global trade is backed by some kind of short-term trade finance.
Global supply chains are yet to be fully restored following the impact of Covid-19. The disruptions are further exacerbated by the ongoing military conflict in eastern Europe.
In this unpredictable scenario, supply chain financing has indeed become a reliable solution for small and medium businesses to improve their working capital position and help them scale operations.
To improve transparency in the SCF processes, the Financial Accounting Standards Board (FASB), USA, in late September 2022, issued an Accounting Standards Update (ASU) on the use of supply finance programmes. The updates became effective for the fiscal years starting after 15th December 2022.
This blog post delves into the specifics of this update, the context for its introduction, and its implications for the supply chain finance market.
What Rules Apply to Supply Chain Financing Disclosures?
FASB’s new disclosure requirements were formulated in response to requests from industry stakeholders and investors for greater transparency regarding buyers’ use of supply chain financing facilities.
Under the updates, buyer firms need to disclose qualitative and quantitative information regarding their supply chain financing programmes.
The buyer must disclose the following information during each annual reporting period:
- Key conditions of the SCF programme, including payment terms, guarantees provided, and assets pledged to financiers for securing such facilities.
- For invoices confirmed as valid by the buyer to banks and financial intermediaries-
- The outstanding amount is due by the buyer at the end of the annual period.
- b) A description of how such outstanding dues are shown on the balance sheet.
- c) A roll-forward of such outstanding payables during the fiscal period. This must include the total amount of liabilities confirmed as well as the amount eventually paid for the obligations.
Also, at the end of each interim period, buyers must disclose the total amount of outstanding obligations they have confirmed as valid to the financier during that interim reporting period.
The Rationale Behind New Disclosure Requirements
Financial analysts and accounting professionals have long expressed concerns about the opacity of supply chain finance programmes and ambiguity in presenting SCF obligations in financial statements.
Also, some critics of SCF were doubtful about struggling businesses using supply chain finance facilities to camouflage debts as trades payable.
The following three reasons justify the change in SCF disclosures.
Lengthy payment terms
Buyer firms in certain industries were using supply chain finance programmes to extend their credit periods with their suppliers while providing them with early payment convenience.
Investors and other accounting analysts, such as auditors, sought to better understand buyers’ usage of SCF programmes to assess working capital sources and the possible risks due to extended payment terms with suppliers.
Ambiguity regarding the balance sheet reporting of SCF obligations
There is no general agreement on accounting for outstanding obligations under supply chain financing in financial statements. Some accountants and analysts believe SCF programme obligations should be reported as short-term debts or as a separate line item in the balance sheets rather than accounts payable.
Furthermore, while some stakeholders prefer a separate presentation for all such obligations, others argue that only a subset of such obligations requires separate reporting.
Because of this ambiguity, uniform guidelines for SCF presentation in balance sheets were required.
Lack of precise GAAP disclosure requirements regarding buyers’ participation in SCF schemes
The Generally Accepted Accounting Principles (GAAP) does not provide any disclosure demands on the nature, activity during the period, variations from period to period, and potential extent of buyers’ involvement in the SCF programme. This information is essential for an investor’s analysis.
Supply Chain Finance: 5 Key Implications of the New Rules
The changes to the disclosure norms impose some operational demands on the participant buyers of supply chain finance programs. However, the overall payoff of its implementation will be favourable in the long run.
Some Important Impacts:
Buyers’ use of supply chain finance programmes and the details of those programmes are now more transparent. This gives external stakeholders like investors, financial analysts, banks, etc. a clearer understanding of the impact of such schemes on the firm’s working capital, cash flow, and liquidity.
Standardised Accounting Treatment of Supply Chain Finance Obligations
The new updates clarify how SCF programme obligations should be reported in the balance sheet. This standardisation in financial reporting prevents firms from reclassifying supply chain finance obligations as short-term debts rather than accounts payable in their balance sheets. Such a regrouping would have altered important debt ratios, lowering firms’ credit rating and thereby increasing their cost of capital.
Global Application of The New Disclosure Norms
The GAAP established by the FASB in the United States, and the International Financial Reporting Standards (IFRS), established by the International Accounting Standards Board (IASB), are the two most widely used reporting standards worldwide.
The first accounting organisation to investigate the subject of disclosures for supply chain finance was FASB. ISAB was later consulted on how SCF can be disclosed under its standards, prompting the organisation to develop new standards. IASB standards are also expected to go into effect this year.
Retrospective Application of Disclosure Guidelines
Businesses are required to implement this guidance retrospectively for all periods for which the balance sheet is presented, except for the roll-forward requirement. The requirement will increase the operational intensity, necessitate contract changes with financiers and suppliers, and raise the compliance cost of financial reporting.
The Disclosure Requirements Don’t Apply to All Types of SCF Programmes
Both the ASU and the proposed disclosure guidelines by IASB pertain only to buyer-initiated supply chain arrangements. The disclosure requirements are limited to the buyers and not the suppliers or finance providers in such SCF programmes.
The new disclosure requirements are unquestionably a positive step towards a more reliable balance sheet. Increased disclosure would not only help investors evaluate specific companies, but it will also make it easier to spot general market trends and potential problems.
It is important to note that these guidelines have only changed the reporting requirement, not the accounting requirement. As a result, the changes are unlikely to hurt supply chain financing arrangements.
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