Question

There has been increasing discussion with respect to the accounting treatment of trade payable programs and whether the obligations of the entity that owes the receivable (the “company”) under these programs should continue to be treated as trade payables on their balance sheet or, instead, be reflected as short-term debt obligations. These trade payables programs - also known as supply chain finance programs, structured payables programs and reverse factoring arrangements, among other labels - have grown in popularity since the 2008-10 financial crisis and have recently drawn more attention from auditors and ratings agencies. The question of whether a payables program is treated as trade payables or short-term debt is critical not only for the purpose of financial disclosures, but also because of knock-on effects in many areas, including loan agreement covenants, executive compensation and rating agency and investor analysis. The 2018 bankruptcy of Carillion plc in the United Kingdom cast a spotlight on the trade payable financing products, with critics arguing that Carillion’s use of the product obscured the ability of investors and other third-parties to assess the financial health of the company. In the fall of 2019, this issue was pushed to the forefront as the “Big Four” accounting firms submitted a joint letter to the Financial Accounting Standards Board (“FASB”) asking that FASB clarify the financial statement disclosure requirements for trade payable programs. In its Report on Activities for Fiscal Year 2019, the Office of the Investor Advocate of the SEC reiterated the call for FASB to provide clarity on the issue. Rating agencies and industry groups have also been actively focused on this issue, especially since the advent of “fintechs” and artificial intelligence has led to a proliferation of novel structures and approaches in this product area. While the supply chain and receivables finance industry awaits clarification from FASB, the general consensus seems to be that the core question for determining whether a trade payable financing program obligation constitutes a trade payable or a short-term debt obligation is whether the program changes the fundamental character of the payment obligations. As this is largely a facts and circumstances determination, a review of all the features of a trade payables program is important. Discuss your opinion on this issue, providing examples of your prior experience or current experience on the matter as necessary to support your arguments. What key factors should be included in the discussion? Conclude with supporting arguments and research if necessary, on the issue. .

Answer 1

The discussion has been increasing with respect to the accounting treatment of trade payable programs and whether the obligations of the entity that owes the receivable under these programs should continue to be treated as trade payables on their balance sheet or, instead, be reflected as short-term debt obligations. These trade payables programs – also known as supply chain finance programs, structured payables programs and reverse factoring arrangements, among other labels – have grown in popularity since the 2008-10 financial crisis and have recently drawn more attention from auditors and ratings agencies. The question of whether a payables program is treated as trade payables or short-term debt is critical not only for the purpose of financial disclosures, but also because of knock-on effects in many areas, including loan agreement covenants, executive compensation and rating agency and investor analysis.

The 2018 bankruptcy of Carillion plc in the United Kingdom cast a spotlight on the trade payable financing products, with critics arguing that Carillion’s use of the product obscured the ability of investors and other third-parties to assess the financial health of the company. In the fall of 2019, this issue was pushed to the forefront as the “Big Four” accounting firms submitted a joint letter to the Financial Accounting Standards Board (“FASB”) asking that FASB clarify the financial statement disclosure requirements for trade payable programs. In its Report on Activities for Fiscal Year 2019, the Office of the Investor Advocate of the SEC reiterated the call for FASB to provide clarity on the issue.  Rating agencies and industry groups have also been actively focused on this issue, especially since the advent of “fintechs” and artificial intelligence has led to a proliferation of novel structures and approaches in this product area.

While the supply chain and receivables finance industry awaits clarification from FASB, the general consensus seems to be that the core question for determining whether a trade payable financing program obligation constitutes a trade payable or a short-term debt obligation is whether the program changes the fundamental character of the payment obligations. As this is largely a facts and circumstances determination, a review of all the features of a trade payables program is important. Key factors often considered include, among other things, (i) the magnitude to which the payables program changes the amount or the term of the company’s payment obligations, (ii) whether payment terms are consistent across the company’s supplier base regardless of whether a supplier participates in the payables program, (iii) whether the financier receives confirmations or guarantees from the company regarding payment of the company’s payment obligations beyond the purchase of the payable itself and (iv) how much the company has control over, or participates in, the negotiations between the financier and the company’s suppliers concerning the factoring of the company’s payables. We look forward to more guidance.