The IFRS Interpretations Committee recently considered the issue of reverse factoring arrangements.
In such arrangements, a financial institution agrees to pay amounts an entity owes to the entity’s suppliers, and the entity agrees to pay the financial institution at a later date. The request came from Moody’s Investors Service, which reported that while 50% of companies use reverse factoring or other supply chain financing arrangements, “fewer than 5% of the entities rated by MIS are actually disclosing their usage together with the impact on their financial statements and risk profile.” Among other consequences, they noted that “stakeholders such as credit rating agencies cannot effectively evaluate aggregate leverage, and bondholders could potentially be frustrated in their ability to set and manage debt covenants effectively and consistently.” The submission also made an interesting point about asymmetric disclosure – that banks and other funding providers who provide these facilities, in conjunction with participating in a company’s core financing facilities, “are better sighted on the company’s aggregate funding requirements than other debt creditors such as bondholders who may primarily rely on reported information.”
The Committee didn’t add the item to its standard-setting agenda, concluding that the issues arising can be adequately analyzed with references to existing principles and requirements. Let’s summarize some of the main points noted in the tentative agenda decision.
The amounts payable by an entity to financial institutions under such arrangements may not meet the definition of trade payables in that they don’t meet all three criteria of representing a liability to pay for goods or services; being invoiced or formally agreed with the supplier; and being part of the working capital used in the entity’s normal operating cycle. Nevertheless, their nature and function might sometimes be viewed as similar enough to trade payables that there’s no need to present them separately. The Committee noted that they would be presented separately “when the size, nature or function of those liabilities makes separate presentation relevant to an understanding of the entity’s financial position,” and commented: “In assessing whether to present such liabilities separately (including whether to disaggregate trade and other payables), an entity considers the amounts, nature and timing of those liabilities.” Factors relevant to this include “whether additional security is provided as part of the arrangement that would not be provided without the arrangement, and “whether the terms of liabilities that are part of the arrangement are substantially different from the terms of the entity’s trade payables that are not part of the arrangement.” In many cases it’s presumably the case that if the company went to the trouble and expense of negotiating and maintaining the arrangement, its existence and magnitude might be of interest to many stakeholders.
In turn, an entity’s assessment of the nature of the liabilities arising from the arrangement may help in determining the nature of the related cash flows as arising from operating or financing activities: “For example, if the entity considers the related liability to be a trade or other payable that is part of the working capital used in the entity’s principal revenue-producing activities, the entity presents cash outflows to settle the liability as arising from operating activities in its statement of cash flows. In contrast, if the entity considers that the related liability is not a trade or other payable because the liability represents borrowings of the entity, the entity presents cash outflows to settle the liability as arising from financing activities in its statement of cash flows.”
On other disclosure matters, the Committee noted that reverse factoring arrangements often give rise to liquidity risk because:
- the entity has concentrated a portion of its liabilities with one financial institution rather than a diverse group of suppliers. The entity may also obtain other sources of funding from the financial institution providing the reverse factoring arrangement. If the entity were to encounter any difficulty in meeting its obligations, such a concentration would increase the risk that the entity may have to pay a significant amount, at one time, to one counterparty.
- some suppliers may have become accustomed to, or reliant on, earlier payment of their trade receivables under the reverse factoring arrangement. If the financial institution were to withdraw the reverse factoring arrangement, those suppliers could demand shorter credit terms. Shorter credit terms could affect the entity’s ability to settle liabilities, particularly if the entity were already in financial distress.
These considerations might lead to disclosing the entity’s objectives, policies and processes for managing the risk, summary quantitative data about the entity’s exposure to liquidity risk at the end of the reporting period (including further information if this data is unrepresentative of the entity’s exposure to liquidity risk during the period), and concentrations of risk. It might also be appropriate to highlight significant judgments applied in determining the accounting treatment.
Interested parties may comment on the tentative agenda decision by September 30, 2020. And, of course, relevant entities can take inspiration from it right away.
The opinions expressed are solely those of the author