Is Supply Chain Finance Constricted by Accounting Rules?
- April 7, 2015 2:38 AM
Categories: Accounting Treatment, Supply Chain Finance | Tags: Reclassify Trade Payables
Categories: Accounting Treatment, Supply Chain Finance | Tags: Reclassify Trade Payables
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:
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.
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:
- 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.
- 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.
- 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.
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